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FOREIGN   EXCHANGE 

THEORY  AND   PRACTICE 


By 
THOMAS   YORK,  A.M.    • 

FOREIGN  EXCHANGE  EDITOR,  WALL  STREET  JOURNAL 


,«•     •••••     • 


NEW  YORK      < 
THE   RONALD    PRESS   COMPANY 
1920 


^oo-^'^' 


Econ.  Dept.  Econ.  lA.  Main  Library 

Copyright,   1920,  by 
The  Ronald  Press  Company 


All  Rights  Reserved 


•  •  •  •  *p  •    « 

*  •    •  •_  «  «    ♦ 


TO 

I.  S.  Y. 


417277 


PREFACE 

Foreign  exchange  is  attracting  more  attention  than  any  other 
branch  of  finance.  The  interest  evinced  is  universal  and  is  no 
longer  confined  to  bankers,  international  traders,  and  financial 
writers,  as  was  the  case  prior  to  the  Great  War.  The  general 
public  is  showing  a  decided  disposition  to  acquaint  itself  with  the 
dislocation  of  the  exchanges  brought  about  by  the  conflict. 
Nor  is  this  interest  likely  to  suffer  much  abatement,  since  normal 
conditions  will  probably  not  be  restored  in  international  financial 
relations  for  a  number  of  years  to  come. 

The  author's  purpose  in  this  book  is  to  explain  the  operation 
of  the  exchanges  between  gold-standard  countries  under  normal 
financial  conditions.  In  a  subsequent  volume  now  in  prepara- 
tion he  proposes  to  deal  with  the  present  irregular  position 
of  the  exchanges,  and  with  exchange  between  a  gold-  and 
a  silver-standard  country.  It  is  quite  impossible,  however, 
to  gain  an  adequate  appreciation  of  the  problem  presented  by 
the  deranged  condition  of  the  exchanges  unless  their  operation 
under  the  normal  functioning  of  the  commercial  and  financial 
machinery  of  the  world  is  first  thoroughly  understood. 

The  subject  of  foreign  exchange,  even  in  its  greatest  refine- 
ments, offers  comparatively  little  difficulty  after  the  student  has 
once  mastered  the  meaning  of  the  gold  standard,  or  what  con- 
stitutes money  in  a  gold-standard  country.  The  present  volume, 
therefore,  attempts  to  give  in  the  introductory  chapter  a  com- 
plete understanding  of  this  fundamental  principle  of  all  finance. 

A  hypothetical  method  of  treatment  is  followed  in  the  theo- 
retical part  of  the  discussion.  This  approach  has  proved  of  great 
assistance  to  the  writer  in  evolving  the  various  principles  laid 
down  in  the  book,  and  will  enable  the  reader  to  follow  the  course 


VI  PREFACE 

of  reasoning  more  closely.  In  the  last  few  chapters  the  hypo- 
thetical assumptions  are  abolished  and  attention  is  given  to  prac- 
tical foreign  exchange  operations  as  conducted  in  the  New  York 
market. 

Thomas  York. 
New  York  City, 
January  i,  1920. 


CONTENTS 

Chapter  Page 

Vl    The  Fundamental  Theory  of  Foreign  Exchange         i 

Foreign  Exchange  Defined 

Money  the  Medium  of  Exchange 

Gold  as  a  Standard  of  Values 

Coining  Gold 

What  the  Gold  Standard  Really  Is 

The  Status  of  Subsidiary  Coins 

Two  Elements  of  Money 

High  Development  of  Monetary  Credit  System 

Analysis  of  a  Foreign  Exchange  Transaction 

An  Illustrative  Transaction 

DifiFerent  Types  of  Foreign  Exchange  Transactions 

Hypothetical  Method  of  Treatment  Followed 

II    Spot  Cable  Exchange 14 

Spot  Cable  Exchange  Defined 

A  Simple  Case 

Technical  Expressions 

Two  Methods  of  Quoting  Exchange 

Demand  and  Supply  of  Exchange 

Various  Classes  of  Exchanges 

Sources  of  Exchange  Supplies 

The  Exchange  Rate  at  a  Discount 

The  Gold  Export  Point  of  the  Spot  Cable  Rate 

The  Upper  Limit 

A  Sample  Case 

Calculating  the  Gold  Export  Point 

Varying  Gold  Export  Points 

The  Gold  Import  Point  of  the  Spot  Cable  Rate 

Calculating  the  Gold  Import  Point 

Both  Specie  Points  Variable 

Minor  Factors  Affecting  the  Specie  Points 

Specie  Points  When  Rates  Are  Expressed  in  Foreign  Gold 

III    The  Dual  System  of  Exchange 34 

An  Exchange  Market  in  Both  Cities 
Unity  of  the  Two  Markets 
Two  Distinct  Viewpoints 
Manner  of  Quoting  Rates 

Exchanges  Between  People  of  Different  Countries 
Graphic  Illustration  of  the  Two  Exchange  Markets 
The  Tendency  of  the  Spot  Cable  Rates  in  the  Two  Cen- 
ters to  Balance 

vii 


viii  CONTENTS 

Chapter  Page 

Another  Example 

The  Effect  of  Disparity  of  Exchange  Rates 

Spot  Cable  Rates  in  Two  Centers,  Each  Below  "Parity" 

of  Other 
Effect  of  Rates  Below  Parity 
Further  Observations  on  Parity  Relations 
Process  of  Adjustment  to  New  Level 
Concurrent  Specie  Points  in  the  Two  Centers 
Effect  of  Different  Quotation  Methods  in  Two  Cities 
New  York  Gold 

IV  Future  Cable  Exchange  .  .  .  > S3 

Future  Cable  Exchange  Defined 

Typical  Future  Exchange  Transaction 

Sources  of  Future  Exchange 

Delivery  Dates 

Spot  and  Future  Cable  Rates  at  Mutual  Parity 

Relation  of  Spot  and  Future  Rates  Illustrated 

Calculating  Spot  and  Future  Cable  Rates 

Tendency  Toward  Mutual  Parity 

Means  of  Parity  Readjustment 

Gold  Export  Point  of  Future  Cables 

The  Future  Export  Rate 

Gold  Import  Point  of  Future  Cable  Exchange 

Relation  of  Specie  Points  to  Shipments 

Future  Exchange  Traded  in  in  Both  Cities 

Future  Cable  Rates  Expressed  in  Foreign  Gold 

V    Demand  Exchange 70 

Limitations  of  Cable  Transfer 

Demand  Exchange  Defined 

Relation  of  Demand  and  Spot  Cable  Rates  at  Mutual 
Parity 

A  Typical  Case 

A  Sale  of  Exchange 

Demand  Exchange  Tends  to  Parity  With  Spot  Cables 

Difference  Less  Than  Parity  Spread 

Parity  Relationship  Realized 

Gold  Export  Point  of  Demand  Exchange 

Parity  of  Export  Rates 

Gold  Import  Point  of  Demand  Exchange 

Demand  Rate  Below  Import  Point 

Demand  Exchange  Transacted  in  Both  Centers 

Demand  Exchange  Under  the  Second  System  of  Quota- 
tion 

Future  Demand  Exchange 

VI    Long  Exchange 86 

Long  Exchange  Defined 


CONTENTS  ix 

Chapter  Page 

Methods  of  Handling  Long  Bills 

An  Alternative  Procedure 

Negotiating  a  Long  Bill  in  New  York 

Long  and  Demand  Exchange  Rates 

Parity  of  Long  and  Demand  Exchange 

Long  Exchange  at  a  Premium 

Investment  Buying  of  Long  Bills 

Long  Bills  as  Instruments  of  Short-Time  Borrowing 

Reasons  for  Issuing  Long  Bills 

Long  Bills  Quoted  According  to  Their  Security 

Formula  for  Parity  Rate  of  Long  Bills 

Quoting  Long  Bills  in  Terms  of  Foreign  Gold 

Long  Bills  Issued  in  London  upon  New  York 

VII    Triangular  Exchange loi 

Transactions  Between  Two  Cities  Settled  by  Payment 
in  a  Third 

A  Triangular  Example 

Tendency  of  Exchange  Rates  to  Triangular  Parity 

Parity  Disturbed 

Tendency  to  Three-Cornered  Equilibrium 

One  Rate  Determined  by  Extent  of  Deviation  Between 
Other  Two 

Alternative  Methods  of  Remitting  in  Triangular  Ex- 
change 

Exchange  Effected  Through  Two  or  More  Intermediate 
Points 

\ 

VllI    The  Foreign  Exchange  Banker iii 

Hypothetical  Conditions  Discontinued 

Function  of  the  Foreign  Exchange  Bankers 

Business  of  Foreign  Exchange  Banking 

Foreign  Exchange  Banker  Lends  His  Credit 

Bank  Balances  of  Foreign  Exchange  Banker 

"Commercial  Business"  of  Foreign  Exchange  Banker 

Open-Market  Trading 

Financial  Operations  of  Foreign  Exchange  Banker 

Miscellaneous  Activities  of  Foreign  Exchange  Banker 

IX    Sterling  Cable  AND  Demand  Exchange  in  Practice    119 

Only  Pre- War  Conditions  Considered 

The  American  Monetary  System 

The  British  Monetary  System 

Sterling  and  Dollar  Exchange 

Rates  Expressed  in  Dollars  in  Both  Cities 

Trading  in  Cable  Transfers 

Trading  in  Demand  Exchange 

Standard  Quotations  and  Speculative  Risks 


X 

Chapter 


CONTENTS 


Page 


"Swapping"  Demand  Exchange  for  Cables 

Gold  Shipments 

Final  Disposition  of  Gold  Shipment 

X    Commercial   and    Bankers'    Long   Sterling   Bills    135 

Financing  Exports  by  Long  Sterling  Bills 

The  Cotton  Bill 

The  Letter  of  Credit 

Computing  the  Price  of  a  Long  Commercial  Bill 

Commercial  and  Bankers'  Bills  Compared 

Calculating  Price  of  Cotton  Bill 

Procedure  of  Purchasing  Bank  ' 

Documentary  Acceptance  Bills 

The  "Domiciled  "Bill 

The  Documentai-y  Payment  Bill 

Clean  Commercial  Bills 

Sterling  Import  Credit 

Dollar  Export  and  Import  Credits 

Brief  Analysis  of  Dollar  Credits 

Long  Bankers'  Sterling  Bills 

Bills  Issued  for  Relending 

Issue  of  a  Finance  Bill 

"One-Name"  and  "Two-Name"  Long  Bankers*  Bills 

Renewal  and  "  Swapping  "  of  Long  Bills 

Investment  Demand  for  Long  Bills 

Date  Bills 

Intercity  Loans;  Other  Types 

The  Sterling  Loan 

Example  of  a  Sterling  Loan 

The  Dollar  Loan 

Payment  of  International  Bond  Issues 


XI     Other  Foreign  Exchanges  in  New  York  . 

Settlements  Between  Various  Countries 

Exchanges  Quoted  in  New  York 

Franc  Exchange 

Mark  Exchange 

Canadian  Exchange 

Countries  Dealt  with  by  New  York 

Triangular  Parity  when  Rates  Are  Quoted  as  Usual 

The  Narrow  Market  and  Readjustment 

Swapping  Foreign  Currencies  in  New  York 


160 


Appendix    A— Practical  Problems  in  Foreign  Exchange     .     167 
B— Glossary  of  Foreign  Exchange  Terms     .      .     170 


FOREIGN  EXCHANGE 

CHAPTER  I 

THE  FUNDAMENTAL  THEORY  OF  FOREIGN 
EXCHANGE 

Foreign  Exchange  Defined.— The  expression  "foreign  ex-  / 
change"  refers  to  the  exchange  of  money  in  one  country  for  money 
in  another.  In  the  vast  majority  of  cases  the  money  exchanged 
is  in  the  form  of  bank  deposits.  A  merchant  in  New  York  who 
has  contracted  to  settle  in  London  for  a  bill  of  goods  he  has  pur- 
chased on  the  other  side,  makes  payment  with  a  London  bank 
deposit,  which  he  secures  in  exchange  for  a  portion  of  his  bank  de- 
posit in  New  York.  He  goes  to  a  foreign  exchange  banker  who 
carries  a  bank  deposit  in  London  for  the  accommodation  of  cus- 
tomers like  himself,  and  exchanges  a  check  on  his  own  bank  for  a 
check  on  a  London  bank,  which  he  remits  to  the  British  seller.         .1  i- 

But  money,  including  bank  deposits,  in  a  gold-standard  coun-  ^qV-*' 
try  consists,  as  we  shall  presently  see,  of  gold,  or  claims  upon  the 
government  or  banks  for  delivery  of  gold  upon  demand.  Pay- 
ments effected  by  transfer  of  bank  deposits  are,  therefore,  equiva- 
lent to  tenders  of  the  metal  at  the  banks.  As  the  monetary 
systems  of  both  the  United  States  and  England  are  normally  on  a 
gold-standard  basis,  a  bank  deposit  in  New  York  is  equivalent  to 
gold  tendered  in  New  York,  while  a  bank  deposit  in  London  is 
equivalent  to  gold  tendered  in  London.' 

As  conducted  between  two  gold-standard  countries,  foreign 
exchange,  therefore,  consists  essentially  of  the  exchange  of  gold 

» We  are  assuming  conditions  in  England  as  they  existed  prior  to  the 
outbreak  of  the  Great  War,  when  the  gold  standard  was  effectively  main- 
tained there. 

I 


2  FOREIGN  EXCHANGE 

in  the  one  for  gold  in  the  other.  In  lieu  of  actually  shipping  the 
metal  to  pay  a  debt  in  London,  an  American  acquires  by  ex- 
change its  equivalent  in  London  in  the  shape  of  a  bank  deposit. 
Thus,  foreign  exchange  is,  in  effect,  merely  another  method  of 
transferring  gold  from  one  place  to  another. 

Money  the  Medium  of  Exchange. — Why  money  in  a  gold- 
standard  country  is  gold  or  its  equivalent  in  the  form  of  govern- 
ment and  bank  obligations  to  pay  it  on  demand,  requires  for  an 
answer  a  thorough-going  exposition  of  the  principles  of  the  gold 
standard.  In  fact,  without  such  exposition,  it  is  almost  futile 
to  attempt  an  analysis  of  the  laws  governing  foreign  exchange 
operations. 

Commodities  and  services  are  not,  of  course,  exchanged  di- 
rectly, but  through  the  medium  of  money.  The  farmer  exchanges 
his  crops  for  money,  and  then  re-exchanges  the  money  for  the 
various  articles  he  desires.  Moreover,  when  he  lends  whatever 
surplus  his  land  produces  over  and  above  his  immediate  needs,  he 
advances,  not  the  identical  product  of  his  soil,  but  the  money  he 
first  obtains  in  exchange  for  it;  and  when  the  loan  is  repaid,  it  is, 
again,  money  he  receives. 

Thus  money  facilitates  the  general  process  of  exchanging  and 
lending  commodities  and  services.  As  a  natural  corollary  of  this, 
money  also  serves  as  a  common  denominator  for  measuring  the 
comparative  exchangeability  or  value  which  a  certain  quantity 
of  an  article  or  a  particular  class  of  service  possesses  as  regards 
other  articles  and  services.  In  short,  money  is  the  common 
medium  of  exchange  and  standard  of  economic  values. 

Gold  as  a  Standard  of  Values. — As  the  value  of  a  commodity  in 
the  economic  sense  is  merely  the  amount  of  another  commodity 
it  commands  in  exchange,  it  stands  to  reason  that  money  itself 
must  be  a  commodity.  In  practically  all  the  important  countries 
of  the  world  the  commodity  adopted  to  fulfil  the  monetary  func- 


THE  FUNDAMENTAL  THEORY  3 

tion  is  the  metal  gold.  Now,  like  many  another  commodity, 
gold  is  measured  by  weight,  and  its  quantity,  even  when  it  is 
employed  as  money,  can  be  indicated  by  the  ordinary  scales  of 
weights — ^pounds  and  ounces,  and  grams  and  kilograms.  But 
the  various  nations  have  seen  fit  to  fix  upon  special  systems  of 
weights  for  measuring  it  when  serving  as  money.  In  the  United 
States  the  system  consists:  first  of  the  standard  unit — the  dollar, 
weighing  23.22  grains;  then  of  the  eagle,  weighing  ten  times  the 
dollar;  the  dime,  weighing  yV  of  the  dollar;  the  cent,  weighing  y^-g- 
of  the  dollar;  and  the  mill,  weighing  ttot  of  the  dollar.  In  Eng- 
land the  monetary  system  of  weights  is  composed  of  the  pound 
sterling,  weighing  113  ^Jy  or  11 3.001  +  grains;  the  shilling,  weigh- 
ing -^  of  the  pound;  the  penny,  weighing  ^0"  of  the  pound;  and 
the  farthing,  weighing  -g^^  ^^  of  the  pound. 

/  It  must  be  carefully  borne  in  mind,  then,  that  the  monetary 
units  in  a  gold-standard  country  always  refer  to  definite  c[uanti- 
ties  of  gold.  Failure  to  appreciate  this  fact  is  responsible  for 
most  of  the  popular  misconceptions  regarding  monetary  ques- 
tions. If,  for  example,  it  is  said  that  a  house  is  worth  $1,000  the 
meaning  is  simply  that  it  is  exchangeable  for  23,220  grains 
(1,000  X  23.22  grains),  or  48!  troy  ounces  of  gold. 

Coining  Gold. — Conceivably  gold  could  perform  its  monetary 
function  in  whatever  shapes  and  sizes  it  chanced  to  be.  But  in 
that  case  it  would  be  necessary  on  every  occasion  of  its  transfer, 
from  buyer  to  seller,  or  between  lender  and  borrower,  to  verify 
its  quantity  by  means  of  a  pair  of  scales  and  a  more  or  less  elabo- 
rate metallurgical  test.  It  is  to  obviate  the  need  of  such  intermi- 
nable weighings  and  testings  that  the  metal  is  fashioned  into 
stamped  disks  of  regular  shape,  called  "coins,"  which  cannot  be 
tampered  with  without  detection,  each  of  a  standard  weight  as 
expressed  by  the  monetary  unit.  But  obviously,  unless  the  coins 
are  executed  by  some  trustworthy  agent  who  commands  the  ab- 
solute confidence  of  the  general  public,  little  would  be  gained  by 


4  FOREIGN  EXCHANGE 

their  manufacture.  It  is  only  natural,  then,  that  in  modern  com- 
munities the  government,  in  whom  the  public  reposes  more  trust 
than  in  private  individuals  or  corporations,  should  be  given  the 
exclusive  right  to  mint  the  coins. 

Gold  coined  by  the  mint  belongs  to  private  parties  and  not  to 
the  government.  The  government  merely  proves  and  certifies 
the  quantity  of  the  gold  by  stamping  the  pieces  into  which  it  is 
divided,  for  anyone  presenting  it  at  the  mint.  That  is  the 
meaning  of  the  statement  that  the  coinage  of  gold  is  free  and 
unlimited.  In  effect,  the  government  puts  the  metal  up  into 
standardized  packages,  each  bearing  the  government's  seal,  and 
thereby  endows  the  metal  with  ready  acceptability  in  hand-to- 
hand  circulation. 

The  metal  is  never  coined  pure,  but  a  certain  proportion  of 
base  metal  alloy,  usually  one-tenth  or  one-twelfth  of  the  gross 
weight,  is  mixed  with  it  to  render  it  harder  and  reduce  the  loss 
from  wear  and  tear.  In  ordinary  transactions,  however,  the 
alloy  is  completely  ignored,  only  the  pure  gold  content  being  con- 
sidered. Gold  coins  of  the  United  States  contain  copper  alloy 
in  the  proportion  of  one  part  of  copper  to  nine  parts  of  gold, 
which  makes  the  gross  weight  of  the  dollar  25.8  grains  (V^-  X 
23.22).  Governments  either  mint  the  coins  gratuitously  or  ex- 
act a  fee  by  retaining  a  portion  of  the  bullion.  The  United  States 
Government  charges  only  for  the  cost  of  the  alloy,  not  for  the 
service  of  coining. 

What  the  Gold  Standard  Really  Is, — In  a  country  possessing 
the  absolute  gold  standard,  the  very  fact  that  the  monetary  unit 
always  refers  to  gold  makes  every  contract  in  that  country  stipu- 
lating the  payment  of  a  certain  number  of  monetary  units,  pay- 
able in  gold  and  in  gold  only,  if  the  payee  so  requires.  Did  the 
monetary  system  of  the  United  States,  for  example,  conform 
strictly  with  the  principle  of  the  gold  standard,  every  promise 
to  pay  a  certain  number  of  dollars,  no  matter  how  evidenced, 


THE  FUNDAMENTAL  THEORY  5 

whether  by  an  engraved  note,  or  an  ordinary  note  of  hand,  a 
bond  or  mortgage,  a  bank  deposit  or  a  book  account,  would  con- 
stitute an  obligation  to  deliver  to  the  creditor,  on  the  due  date 
and  at  the  place  specified,  a  definite  quantity  of  gold.  In  short,! 
when  the  gold  standard  is  adopted  in  its  entirety,  gold  only,  in' 
the  coined  form,  is  a  full  legal  tender. 

But  it  by  no  means  follows  that  gold  coin  will  be  the  sole 
medium  of  exchange  under  the  operation  of  the  unqualified  gold 
standard.  On  the  contrary,  creditors  will  ordinarily  waive  their 
right  to  the  coin,  and  consent  to  receive  in  place  of  it  the  more 
convenient  promises  to  pay  gold  on  demand  of  third  parties, 
whose  unquestioned  good  faith  and  ability  to  perform  their  en- 
gagements render  their  obligations  as  acceptable  as  the  metal 
itself.  Nowadays  the  only  agencies  which  are  able  to  issue  de-^ 
mand  obligations  that  will  circulate  on  a  strict  parity  with  gold' 
are  governments  and  banks.  The  promises  of  governments  are 
evidenced  by  silver  and  base  metal  coins,  commonly  referred  to 
as  "subsidiary  coins,'^  and  by  engraved  paper  notes.  Similar 
obligations  of  the  banks  are  represented  by  engraved  paper  notes 
and  so-called  "checking  deposits,"  which  are  nothing  more  nor 
less  than  book  accounts,  any  portion  of  which  can  be  transferred 
by  the  banks^  creditors,  the  depositors,  to  any  other  persons, 
usually  by  means  of  a  formal  written  order  on  the  bank — the 
familiar  check. 

The  Status  of  Subsidiary  Coins. — It  is  a  striking  comment- 
ary on  the  widespread  ignorance  of  monetary  principles  that 
governments  the  world  over  should  fail  to  recognize  their  liability 
on  their  outstanding  subsidiary  coins.  Far  from  making  such 
acknowledgment,  they  actually  consider  the  difference  between 
the  so-called  nominal  value  of  the  coins  (in  reality  the  amount 
of  gold  due  on  them)  and  the  cost  in  gold  of  their  metal  content 
as  a  profit  derived  from  coining  them.  Value  is  here  unwittingly 
regarded  as  being  created  by  means  of  the  stamping  press.    A 


6  FOREIGN  EXCHANGE 

better  example  of  the  fallacious  doctrine  of  fiat  money  could 
hardly  be  found.  The  fact  is  that  subsidiary  coins  are  but 
metallic  promissory  notes  of  the  issuing  government,  and  should 
|formally  be  acknowledged  as  such.  To  be  sure,  since  the  metal 
they  are  made  of  has  an  appreciable  value,  particularly  in  the 
case  of  the  silver  pieces,  the  government's  net  indebtedness  on  its 
outstanding  subsidiary  coins  is  equal  to  the  difference  between 
the  amount  of  gold  it  owes  on  them  and  the  current  gold  value 
of  their  metal  content,  which  the  government  would  acquire 
again  were  it  to  redeem  the  coins. 

Two  Elements  of  Money. — Money,  in  a  country  rigidly  adher- 
ing to  the  gold-standard  principle,  is  thus  composed  of  two  elements 
— gold,  and  the  several  classes  of  government  and  bank  promises 
to  pay  the  metal  on  demand.^  So  long  as  the  government  and 
the  banks  maintain  their  ability  to  meet,  without  demur  or  delay, 
whatever  obHgations  are  presented  for  payment,  it  is  obvious 
that  their  creditors  are  virtually  owners  of  gold  entrusted  to 
them  for  safekeeping.  Hence,  payments  made  with  these  obliga- 
tions are  equivalent  to  transfers  of  titles  to  gold  stored  in  the 
government  treasury,  or  in  this  or  that  bank.  Purchase  of  goods 
with  these  promises,  for  example,  consists,  to  all  intents  and  pur- 
poses, of  the  exchange  of  the  goods  for  gold  lodged  in  the  vaults 
of  the  government  treasury  or  some  bank. 

Because  they  are  more  convenient  to  handle  than  gold  coins, 

"  The  bank  deposit  is  commonly  differentiated  from  the  other  forms  of 
money  which  are  called  "cash,"  because  of  the  greater  formality  connected 
with  its  transfer.  As  the  check,  which  represents  the  portion  of  the  bank 
deposit  about  to  be  transferred,  is  not  in  itself  a  direct  evidence  of  the  bank's 
liability,  every  last  holder  must  guarantee  by  his  indorsement  that  it  will  be 
honored  by  the  bank.  On  the  other  hand  subsidiary  coins,  government 
notes,  and  bank  notes  are  evidences  of  direct  liability  on  the  part  of  the  govern- 
ment and  banks,  and  on  that  account  circulate  as  freely  as  gold  coin  itself, 
passing  from  hand  to  hand  by  the  mere  act  of  delivery.  The  issuance  of  these 
forms  of  money  is  more  strictly  controlled  by  law  than  the  creation  of  bank  de- 
posits, but  such  regulation  is  no  essential  part  of  the  gold-standard  principle. 


THE  FUNDAMENTAL  THEORY  7 

the  demand  promises  of  the  government  and  banks  are  preferred 
by  the  public,  and  constitute  in  consequence  the  great  bulk  of  a 
country's  circulating  medium.  The  gold  coins  are  turned  over  to 
the  government  and  the  banks  in  exchange  for  their  obligations, 
and  are  held  in  reserve  by  them  for  the  purpose  of  meeting 
promptly  whatever  obligations  are  presented  for  redemption. 
By  this  means  the  gold  parity  of  the  great  mass  of  outstanding 
obligations  is  maintained.  As  a  rule,  the  gold  reserves  need 
represent  but  a  fraction  of  the  volume  of  obligations  in  circula- 
tion, as  owing  to  their  high  credit  the  government  and  banks  are 
seldom  called  upon  to  pay  gold  to  creditors.  In  the  ordinary 
course  of  events  the  government's  obligations  are  only  retired 
when  they  are  turned  in  for  taxes,  or  on  the  comparatively  infre- 
quent occasions  when  gold  is  desired  for  export  or  use  in  the  arts. 
They  are  renewed  when  the  government  purchases  supplies  or 
pays  the  salaries  of  its  employees.  The  obhgations  of  the  banks 
are  being  continuously  liquidated  as  borrowers  surrender  them 
in  discharge  of  debts  owed  to  the  banks,  and  are  put  out  again  as 
the  banks  extend  new  loans. 

High  Development  of  Monetary  Credit  System. — This  sys- 
tem of  monetary  credit  is  carried  even  to  a  higher  point  of  de- 
velopment. Instead  of  gold  the  banks  hold  as  reserves  against 
their  liabilities  the  obligations  of  the  government  or  of  a  central 
bank,  or  of  both,  which  their  creditors  will  ordinarily  accept  in  full 
satisfaction  of  their  claims.  In  their  daily  settlements  with  each 
other,  the  banks  use,  as  the  most  convenient  medium  of  payment, 
deposits  in  the  central  bank,  while  in  paying  off  individual  credi- 
tors they  use  the  government's  obligations  in  the  form  of  notes 
and  subsidiary  coins,  or  the  central  bank's  obligations  in  the  form 
of  notes. 

In  this  manner  practically  the  entire  stock  of  gold  in  the  coun- 
try is  concentrated  in  two  large  reservoirs,  the  government 
treasury  and  the  central  bank,  which  constitute  the  basis  for  the 


8  FOREIGN  EXCHANGE 

vast  superstructure  of  credit,  consisting  of  the  obligations,  first, 
of  the  government  and  central  bank,  and  then  of  the  ordinary  run 
of  banks.  But  it  is  to  be  remembered  that  under  the  opera- 
tion of  the  complete  gold  standard  the  obligations  of  the  banks 
are  still  equivalent  to  gold  tendered  at  their  offices,  since  their 
creditors  may  still  demand  payment  in  gold  over  the  counter. 
When  required  to  make  such  delivery,  the  banks  draw  upon 
the  gold  suppHes  in  the  hands  of  the  government  and  the  central 
bank  by  presenting  the  latter's  obligations  for  redemption. 

Analysis  of  a  Foreign  Exchange  Transaction. — Having  es- 
tabhshed  the  fact  that  bank  deposits  in  a  gold-standard  country 
are  equivalent  to  gold,  we  are  prepared  to  resume  our  discussion 
of  foreign  exchange.  It  is  to  be  observed  in  the  first  place  that 
international  settlements  are  usually  effected  by  means  of  bank 
deposits.  Whether  payment  is  made  against  the  purchase  of 
merchandise,  services,  or  securities,  or  by  way  of  advancing  or 
liquidating  a  loan,  or  paying  interest  thereon,  or  on  any  other 
account,  the  payer  in  the  one  country  transfers  to  the  payee  in 
the  other  the  stipulated  amount  of  bank  deposits  in  a  particular 
city.  A  check  is  drawn  on  the  bank,  or  a  cablegram  is  sent  direct- 
ing the  bank  to  make  the  transfer.  As  a  general  rule  the  banks 
whose  obligations  are  thus  employed  in  making  international 
payments  are  the  larger  institutions  located  in  the  financial  cen- 
ter of  the  one  or  the  other  country.  Between  the  United  States 
and  England,  for  instance,  settlement  is  usually  made  by  the 
transfer  of  a  deposit  in  either  a  London  or  a  New  York  bank. 

Taking  the  example  of  a  payment  from  the  United  States  to 
England,  it  makes  a  difference  to  the  American  payer  and  to  the 
British  payee  whether  the  payment  is  to  be  made  in  London  or  in 
New  York,  and  they  accordingly  settle  the  point  in  their  contract. 
The  American  payer  has  his  bank  deposit,  let  us  say,  in  New 
York.  If  he  contracts  to  pay  in  London,  he  must  secure  the 
required  amount  of  deposits  in  a  London  bank.     To  all  intents 


THE  FUNDAMENTAL  THEORY  9 

and  purposes,  then,  he  owns  a  stock  of  gold  warehoused  in  a  New 
York  bank,  but  has  agreed  to  deliver  a  certain  amount  in  London. 
As  has  already  been  learned  he  has  two  methods  available  for 
making  the  transfer.  He  can  withdraw  the  necessary  quantity 
of  gold  from  his  New  York  bank  and  ship  it  to  London;  or  he  can 
exchange  a  portion  of  his  New  York  deposit,  which  we  may  refer 
to  as  ''New  York  gold,"  for  the  needed  amount  of  London  de- 
posits, which  we  may  call  "London  gold,"  with  one  who  desires 
to  make  the  reverse  exchange.  (Usually  only  foreign  exchange 
bankers  ship  the  metal.  But  for  our  present  purposes  we 
shall  assume  that  our  American  payer  is  in  a  position  to  make 
consignments.) 

As  noted  in  the  next  chapter,  the  rate  at  which  the  American 
payer  can  effect  the  exchange  is  not  a  fixed  and  unchanging  pro- 
portion, but  varies  with  the  state  of  competition  prevailing  among 
all  performing  similar  exchanges.  He  may  surrender  a  greater  or 
less  amount  of  his  New  York  gold  than  he  will  obtain  of  London 
gold.  But  even  though  he  should  suffer  a  loss  on  the  exchange, 
it  will  still  advantage  him  to  resort  to  exchange  rather  than  ship-  / 
ment,  if  the  loss  should  be  less  than  the  cost  of  shipping  the  metal, 
as  it  usually  is.  Thus  in  contracting  to  make  payment  in  London 
he  must  take  into  account  the  current  rate  of  exchange,  or  the 
expense  of  transporting  gold,  if  shipment  happens  to  be  cheaper 
than  exchange,  in  order  to  learn  what  the  payment  will  amount  to 
in  terms  of  New  York  gold. 

On  the  other  hand,  if  payment  in  New  York  is  agreed  on,  it 
will  devolve  upon  the  British  payee,  who  naturally  wants  his 
money  at  home,  say,  in  London,  either  to  ship  gold  or  exchange 
the  New  York  gold  he  receives  for  London  gold,  with  one  who  is 
willing  to  make  the  opposite  exchange.  Here  again,  he  will  have 
recourse  to  shipment  only  in  the  event  that  it  is  cheaper  than  ex- 
change. As  he  will  compute  his  receipts  by  the  amount  he  will 
net  in  London,  he  must  take  into  consideration,  when  agreeing 
upon  the  conditions  of  payment,  the  rate  at  which  he  can  accom- 


lO  FOREIGN  EXCHANGE 

plish  the  exchange,  or,  if  shipment  is  cheaper,  the  cost  of  trans- 
porting gold  to  London. 

An  Illustrative  Transaction. — As  a  concrete  illustration  of  the 
way  in  which  a  foreign  exchange  transaction  is  executed,  let  us 
take  the  case  of  a  New  York  merchant  who  contracts  to  purchase 
a  bill  of  goods  from  a  Sheffield  manufacturer  for  £i,ooo,or  1 13,001 
grains  (1,000  X  1 13.001)  of  gold  delivered  in  London.  It  is  evi- 
dent that  in  consequence  of  the  terms  of  payment  he  is  required 
either  to  ship  the  above  amount  of  gold  to  London,  or  to  secure 
by  exchange  that  amount  of  London  deposits. 

Suppose  a  foreign  exchange  banker  agrees  to  make  the  ex- 
change with  him  at  the  rate  of  $4.87  per  £1,  or  1 13.0814  grains 
(4.87  X  23.22)  of  New  York  deposits  for  1 13.001  grains  of  Lon- 
don deposits.  On  this  basis  the  New  York  merchant  will  part 
with  a  total  of  113,081.4  grains  of  his  New  York  deposit,  and  re- 
ceive a  total  of  113,001  grains  of  London  deposits.  He  will, 
accordingly,  suffer  a  loss  of  80.4  grains  on  the  exchange.  But  if 
this  loss  is  less  than  it  would  cost  him  to  ship  113,001  grains  of 
gold  to  London,  he  will  consent  to  make  the  exchange,  which  will 
be  executed  as  follows :  He  will  turn  over  to  the  foreign  exchange 
banker  a  check  on  his  bank  for  $4,870,  or  113,081.4  grains,  and 
receive  from  him  a  check  on  his  London  correspondent  bank  for 
£1,000,  or  113,001  grains,  which  he  will  forward  to  the  Sheffield 
manufacturer. 

Naturally  the  New  York  merchant  reckons  the  cost  of  his 
merchandise  purchase,  not  at  the  invoice  amount  of  113,001 
grains  of  London  gold,  but  at  the  113,081.4  grains  of  New  York 
gold  he  gives  up  on  the  exchange.  In  negotiating  the  purchase, 
therefore,  he  has  regard  to  the  prevailing  rate  of  exchange. 

Different  Types  of  Foreign  Exchange  Transactions. — Essen- 
tially consisting  of  the  exchange  of  two  lots  of  ^old  located  in 
different  countries,  foreign  exchange  transactions  divide  them- 


THE  FUNDAMENTAL  THEORY  II 

selves  into  several  classes  each  based  on  the  time  of  the  two  de- 
liveries. While  the  contracts  for  the  exchanges  are  entered  into 
in  the  present,  they  may  stipulate  simultaneous  delivery  of  the 
two  lots  now  or  at  some  specified  future  time;  or  they  may  call  for 
the  delivery  of  the  domestic  lot  in  the  present  or  a  stated  future 
date,  and  the  foreign  lot  at  some  subsequent  time.  Thus  in  all 
cases,  except  where  the  two  deliveries  are  simultaneous  and  im- 
mediate, the  element  of  time,  and  consequently  the  factor  of 
interest,  figures  in  the  transactions.  The  rates  at  which  two  lots 
of  gold  exchange  in  the  case  of  these  various  types  of  exchange 
must  needs,  therefore,  differ.  But  we  shall  learn,  that  they  tend 
to  mutual  equivalence,  if  proper  allowance  is  made,  through  the 
factor  of  interest,  for  the  variation  in  the  time  of  the  two  deliveries. 
In  the  chapters  to  follow  our  task  will  be  mainly  to  examine  each 
of  these  classes  of  exchange,  and  to  define  the  relation  which  their 
respective  rates  bear  each  other  when  in  that  position  of  parity. 

Hjrpothetical  Method  of  Treatment  Followed. — In  the  first 
part  of  our  treatise,  which  will  be  given  over  to  an  analysis  of  the 
principles  underlying  foreign  exchange  transactions,  we  shall  as- 
sume certain  conditions  not  experienced  in  actual  practice.  Such 
hypothetical  mode  of  treating  the  subject  will  greatly  simplify 
our  labor  without  in  the  least  detracting  from  the  value  of  our 
conclusions.  After  we  have  by  this  means  mastered  the  laws  of 
foreign  exchange,  we  shall  pass  to  a  consideration  of  exchange  ^ 
dealings  as  they  are  actually  conducted  between  New  York  and 
London.  Throughout,  however,  our  discussion  will  relate  solely 
to  conditions  as  they  prevailed  prior  to  the  Great  War,  as  only  y 
the  normal  functioning  of  the  exchanges  between  gold-standard 
countries  falls  within  the  scope  of  this  volume. 

To  begin  with,  we  shall  assume  that  both  the  United  States 
and  England  are  on  an  effective  gold-standard  basis,  and  that  in 
consequence  no  question  can  be  raised  with  regard  to  the  equiva- 
lence of  New  York  and  London  bank  deposits  to  gold.    To  keep 


12  FOREIGN  EXCHANGE 

constantly  before  our  minds  the  essential  fact  that  foreign  ex- 
change in  the  last  analysis  is  gold  exchange  between  two  gold- 
standard  countries,  we  shall  refer  to  exchange  between  the  two 
cities  as  the  exchange  of  New  York  gold  for  London  gold,  and 
vice  versa,  though  it  will  be  understood  that  the  subjects  of  ex- 
change are  in  reality  bank  deposits  in  those  cities. 

Secondly,  in  place  of  the  dollar  in  the  United  States  and  the 
pound  sterling  in  England,  we  shall  substitute  the  troy  ounce  of 
480  grains,  customarily  used  by  jewelers  and  other  dealers  in  the 
precious  metals.  Under  this  supposition  gold  coins  in  both 
countries  will  weigh  one  or  more  ounces,  or  fraction  of  an  ounce, 
and  all  values  will,  accordingly,  be  expressed  in  so  many  ounces 
or  grains  of  pure  gold,  instead  of  in  so  many  dollars  and  cents,  or 
so  many  pounds,  shillings,  and  pence. 

By  employing  a  standard  unit  common  to  both  countries,  we 
shall  avoid  the  confusion  inevitably  following  upon  any  attempt 
to  compare  the  weights  of  two  lots  of  gold  that  are  measured  by 
different  units.  The  advantage  of  the  troy  ounce  over  one  of  the 
regular  monetary  units  lies  in  the  fact  that  it  cannot  be  taken  for 
anything  but  what  it  really  is,  namely,  a  unit  of  weight.  For  it 
is  most  essential  in  connection  with  the  study  of  foreign  exchange 
that  the  concept  of  weight  be  constantly  associated  with  whatever 
monetary  unit  is  used.  The  dollar  or  the  pound  sterling  would 
not  serve  our  purpose  so  well,  owing  to  the  vague  notions  gener- 
ally entertained  with  regard  to  their  nature.  It  is  doubtful  if 
any  amount  of  reiteration  that  they  are  but  units  of  weight  es- 
pecially used  in  measuring  gold  when  employed  as  money,  would 
break  the  average  reader  of  the  ingrained  habit  of  regarding  them 
as  something  totally  different,  indefinite  as  that  might  be. 

Finally,  we  shall  eliminate,  in  the  hypothetical  part  of  our  dis- 
cussion, the  foreign  exchange  banker,  who  is  but  a  middleman, 
and  assume  that  the  principals  to  every  exchange  transaction 
come  into  direct  touch  with  each  other.  By  dispensing  with  this 
middleman  we  shall  strip  exchange  dealings  of  their  unimportant 


THE  FUNDAMENTAL  THEORY  I3 

details  and  be  able  to  concentrate  our  attention  entirely  on  their 
essential  features.  Omitting  the  banker,  however,  renders  neces- 
sary the  further  supposition  that  the  exchangers  have  agents  in 
the  foreign  city  to  attend  in  their  behalf  to  the  delivery  or  receipt 
of  gold  there,  and  to  other  matters  connected  with  the  execution 
of  the  exchanges. 


CHAPTER  II 

SPOT  CABLE  EXCHANGE 

Spot  Cable  Exchange  Defined. — Of  the  several  varieties  of 
gold  exchanging  as  based  on  the  relative  time  of  the  two  deliver- 
ies in  New  York  and  London,  that  described  as  "spot  cable  ex- 
change" or  *Hhe  spot  cable  transfer"  is  the  simplest.  Owing  its 
name  to  the  fact  that  the  transmission  of  the  order  for  the  delivery 
of  gold  in  London  is  by  cablegram,  this  type  of  exchange  differs 
J  from  the  other  types  in  that  the  two  deliveries  are  simultaneous 
and  immediate,  or  at  least  not  later  than  the  time  required  to  dis- 
patch a  cablegram  to  the  British  center.  Thus  each  party  to  an 
exchange  of  this  sort  no  sooner  parts  with  gold  in  one  place  than 
he  comes  into  possession  of  gold  in  the  other  place,  so  that  there  is 
no  element  of  interest  involved  in  the  transaction,  as  we  shall  see 
there  is  in  the  case  of  the  other  forms  of  exchange.  For  this 
reason  spot  cable  exchange  is  not  inaptly  characterized  as  "pure 
exchange." 

A  Simple  Case. — The.  accompanying  diagram  illustrates  the 
mutual  relationship  of  the  four  parties  figuring  in  a  simple  spot 
cable  transaction.  The  dotted  lines  connect  the  creditors  with 
their  respective  debtors,  while  the  solid  lines  show  the  direction 
in  which  gold  changes  hands  in  New  York  and  London. 

Suppose  Barton  of  New  York  purchases  from  Simpson  of 
London  a  quantity  of  wool  for  960  ounces  of  gold,  which  he  con- 
tracts to  deHver  at  once  in  London;  and  suppose,  further,  that 
Smith  of  New  York  has  just  sold  a  consignment  of  wheat  to 
Brown  of  London,  and  is  paid  immediately  960  ounces  in  the 
British  capital.  A  situation  is  created  as  a  result  of  these  two 
transactions  in  which,  of  the  two  parties  residing  in  New  York, 

14 


SPOT  CABLE  EXCHANGE 


15 


Barton  has  gold  in  New  York  but  is  called  upon  to  deliver  a 
certain  amount  in  London,  while  Smith  has  gold  in  London  but 
wants  it  transferred  to  New  York.  It  is  obvious  that  by  exchang- 
ing their  respective  holdings,  they  will  save  each  other  the  cost 
and  trouble  of  shipping  the  metal,  provided,  of  course,  they  can 
agree  upon  a  mutually  satisfactory  rate. 


Barton 


Brown 


NEW  YORK    1 


\ 


X 


.^'•' 


.^ 


Smith 


LONDON 


Simpson 


Let  us  say  that  after  a  certain  amount  of  bargaining  Smith 
consents  to  turn  over  to  Barton  the  960  ounces  he  has  in  London 
for  958  ounces  that  Barton  agrees  to  pay  him  in  New  York,  which 
is  presumably  the  rate  at  which  others  are  at  the  same  time  ar- 
ranging similar  exchanges.  Both  parties  thereupon  proceed  to 
carry  out  their  contracts  as  follows:  Barton  dehvers  to  Smith 
958  ounces  in  New  York,  while  Smith  cables  his  debtor.  Brown, 
in  London  to  deliver  to  Simpson  for  Barton's  account,  the  960 
ounces  owing  him.  Thus  within  a  few  hours  the  exchange  of  the 
two  lots  of  gold  is  completed  and  the  necessity  of  making  two 
cross-shipments  avoided.  Owing  to  the  competitive  conditions 
prevailing  among  the  exchangers  in  New  York,  Smith  loses  and 
Barton  gains  2  ounces  on  the  exchange.  But  Smith  is  perfectly 
satisfied  with  the  bargain,  as  it  is  to  be  supposed  that  a  physical 
transfer  of  his  gold  from  London  would  have  cost  him  more  than 
the  amount  of  this  loss.    Besides,  he  took  the  loss  fully  into 


I6  FOREIGN  EXCHANGE 

account  when  he  decided  to  sell  his  wheat  for  960  ounces  of 
London  gold. 

Technical  Expressions. — At  this  point  it  is  advisable  to  ex- 
plain some  of  the  technical  expressions  commonly  employed  in 
ij  connection  with  exchange  dealings,  particularly  as  they  will  prove 
useful  in  our  own  discussion.  To  begin  with,  an  exchange  oper- 
ation is  customarily  viewed  as  an  ordinary  purchase  and  sale,  in 
which  the  local  gold  is  regarded  as  the  purchase  money  and  the 
foreign  gold  as  the  commodity.  To  designate  this  "  commodity" 
in  respect  to  the  time  and  place  of  its  delivery,  the  word  "ex- 
change" (less  commonly  "funds"  or  "currency")  is  used  in  con- 
junction with  a  phrase  describing  the  particular  t3^e  of  exchange 
that  is  referred  to,  and  the  name  of  the  city  in  which  the  com- 
modity is  located.  In  the  illustration  above,  for  example.  Smith 
is  looked  upon  as  selling  Barton  960  ounces  of  spot  cable  exchange 
on  London,'  for  which  Barton  is  said  to  pay  him  958  ounces. 
The  act  of  exchange  is  not  infrequently  alluded  to  as  a  "conver- 
sion." New  York  funds  are  said  to  be  converted  into  London 
funds,  and  vice  versa.  Then,  too,  the  purchaser  of  London  ex- 
change. Barton,  in  our  example,  is  represented  as  "sending"  or 
"remitting  funds"  to  London,  while  the  seller  of  London  ex- 
change. Smith  in  our  example,  is  described  as  "withdrawing 
funds"  from  London. 

Two  Methods  of  Quoting  Exchange. — Another  matter  which 
requires  most  careful  attention  at  this  early  stage  of  our  inquiry 
relates  to  the  twofold  manner  in  which  the  rate  of  exchange  may 
be  indicated.  One  of  the  commonest  causes  of  confusion  on  the 
general  subject  of  foreign  exchange  is  the  failure  to  apprehend  and 
to  observe  consistently  the  distinction  between  these  two  meth- 
ods of  expressing  the  rate.     In  the  case  of  either  method,  the 

^  Care  should  be  taken  to  avoid  confusing  the  word  "exchange"  in  this 
narrow  technical  sense  with  its  ordinary  meaning  of  a  reciprocal  act. 


SPOT  CABLE  EXCHANGE  1 7 

rate  of  exchange  denotes  the  ratio  in  which  a  quantity  of  gold  in 
one  city  is  exchanged  for  the  standard  unit  in  the  other  city. 
But  according  to  the  one  system,  which  hereafter  will  be  desig- 
nated as  the  ''first  method  of  quotation,"  the  rate  indicates  the .  / 
amount  of  domestic  gold  which  is  given  in  exchange  for  the  stand- 
ard weight  of  foreign  gold.  In  the  illustration  we  cited,  for 
example,  the  rate  at  which  Barton  and  Smith  perform  their  ex- 
change is  denoted  by  the  ratio  of  479  grains  of  New  York  gold  to 
480  grains  of  London  gold,  which  may  be  expressed  in  the  frac- 
tional form,  thus, 

479  grains  of  New  York  gold 

480  grains  of  London  gold 

But  it  is  obvious  that  when  this  mode  of  quoting  the  rate  is 
in  universal  use  in  any  center,  it  is  only  necessary  to  express  the 
amount  of  domestic  gold  given  in  exchange,  that  is,  the  numerator 
or  upper  term  of  the  ratio,  as  the  quantity  of  foreign  gold  received, 
that  is,  the  denominator  or  lower  term  of  the  ratio,  is  understood 
to  be  480  grains.  The  rate  quoted  above  would  ordinarily  be 
expressed  by  the  single  figure  479  grains.  In  short,  when  the 
first  system  of  quotation  is  employed,  the  rate  of  exchange  is 
expressed  in  terms  of  domestic  gold. 

The  rate,  which  is  also  called  the  ''price  of  exchange,"  fluctu- 
ates in  response  to  changes  in  the  relation  of  the  demand  and 
supply  of  exchange.  It  advances  in  answer  to  an  urgent  demand 
for  foreign  gold,  and  declines  as  the  supply  increases  in  the  foreign 
gold  offerings.  When  the  rate  is  the  standard  unit  of  480  grains, 
it  is  said  to  be  "at  par,"  for  it  then  indicates  that  New  York  gold 
is  exchanging  for  London  gold  on  equal  terms,  480  grains  of  the 
one  for  480  grains  of  the  other.  When  the  rate  rises  above  par, 
say,  to  481  grains  (481  grains  of  New  York  gold  against  480  grains 
of  London  gold),  London  exchange  is  declared  to  be  "at  a  pre- 
mium "  of  I  grain.  On  the  other  hand,  when  the  rate  declines  be- 
low the  par  level  to  479  grains  (479  grains  of  New  York  gold 


# 


1 8  FOREIGN  EXCHANGE 

against  480  grains  of  London  gold),  London  exchange  is  referred 
to  as  selling  *'  at  a  discount"  of  i  grain. 

Quoting  the  rate  in  this  manner  conforms  to  the  way  in 
which  the  values  of  commodities  in  general  are  expressed, 
since  the  figure  denoting  the  rate  indicates  the  price  paid 
for  a  fixed  quantity  of  the  commodity,  or  foreign  gold. 
Largely  on  this  account  it  is  the  method  most  commonly  em- 
ployed, and  is  in  fact  the  one  applied  to  London  exchange  in 
New  York. 

For  reasons  which  will  be  apparent  in  the  next  chapter,  the 
rate  of  exchange  between  some  countries  is  expressed  in  the  re- 
verse manner,  that  is,  in  terms  of  foreign  gold.  According  to 
this  method,  which  we  shall  refer  to  as  the  "second  system  of 
y  quotation,"  the  rate  signifies  the  quantity  of  foreign  gold  that  is 
^  exchangeable  for  the  standard  weight  of  domestic  gold.  If,  for 
instance,  this  mode  of  quoting  the  rate  were  used  in  New  York 
in  relation  to  London  exchange,  a  "rate  of  481  grains"  would  be 
understood  to  mean  that  481  grains  of  London  gold  exchanged  for 
480  grains  of  New  York  gold.  Expressing  the  rate  in  this  manner 
is  precisely  analogous  to  a  system  by  which  the  value  of  an  ordi- 
nary commodity  would  be  indicated  by  stating  the  amount  which 
could  be  purchased  for  $1.  For  example,  the  price  of  wheat 
might  be  given  as  ^  bushel,  with  the  understanding  that  ^  bushel 
could  be  purchased  for  a  dollar. 

Under  the  second  system  of  quoting  the  rate,  the  higher  the 
figure  expressing  it  advances,  the  more  exchange  can  be  pur- 
chased for  480  grains  of  local  gold,  and  therefore,  the  cheaper  it  is; 
and  conversely,  the  lower  the  figure  declines,  the  less  exchange  can 
be  bought  for  480  grains  of  local  gold,  and  the  dearer  it  is.  Ac- 
cordingly, as  the  figure  rises  above  the  par  of  480  grains,  the 
price  of  exchange  really  falls  to  a  discount,  since  480  grains  of 
exchange  can  be  obtained  for  less  than  480  grains  of  local  gold; 
contrariwise,  when  the  figure  declines  below  the  par  of  480  grains, 
the  price  of  exchange  in  reality  goes  to  a  premium,  since  480 


SPOT  CABLE  EXCHANGE  I9 

grains  of  exchange  now  command  more  than  480  grains  of 
local  gold.^ 

Demand  and  Supply  of  Exchange. — Whether  a  person  can 
sell  his  London  exchange  at  a  premium  or  at  par,  or  is  obliged  to 
dispose  of  it  at  a  discount,  will  naturally  depend  upon  the  state  of 
competition  prevailing  at  the  moment  among  all  the  exchangers. 
The  exchange  of  gold  between  New  York  and  London  is  a  two- 
ended  affair,  however,  exchanges  being  executed  in  London  as 
well  as  in  New  York;  for  in  some  transactions  between  Americans 
and  Englishmen  settlement  is  made  by  the  delivery  of  gold  in 
New  York,  and  the  latter  have  occasion,  therefore,  to  negotiate 
exchanges  in  London.  It  will  be  found  more  convenient,  however, 
to  deal  for  the  present  only  with  the  New  York  end  of  this  dual 
system  of  exchange.  We  shall  accordingly  assume  in  this  chapter 
that  payments  between  the  two  cities  are  made  exclusively  in 
London  gold,  and  thus  confine  the  exchange  market  to  New  York; 


*  The  premium  and  discount  on  the  price  of  exchange  always  refer  to  domes- 
tic gold,  inasmuch  as  they  represent  the  difference  between  the  standard 
weight  of  480  grains  of  foreign  gold,  and  the  quantity  of  domestic  gold  it  com- 
mands in  exchange.  Accordingly,  if  the  rate  is  expressed  in  foreign  gold,  it  is 
necessary  to  translate  it  into  terms  of  local  gold  to  ascertain  the,  amount  of  its 
premium  or  discount.  If,  for  instance,  the  rate  for  London  exchange  in  New 
York  were  given  as  479  grains  of  London  gold,  its  premium  would  amount  to 
ifffiT  grains,  which  is  the  difference  between  the  equivalent  quotation  of  48  lire 
grains  of  New  York  gold, 

4°'^"4T»         4°^ 

480     ~  479 

and  the  par  of  480  grains.  The  percentage  of  the  premium  or  discount  is 
found  by  taking  the  difference  between  the  quoted  figure  and  the  par  of  480 
grains,  and  dividing  this  difference  by  whichever  of  the  two  refers  to  foreign 
gold — by  par,  if  the  first  system  of  quotation  is  used,  and  by  the  quoted  figure, 
if  the  second  system  is  employed.  In  the  foregoing  example,  the  premium 
amounts  approximately  to  .2%, 

480  —  479 

i.e., ^^^  =  .002  +. 

479 


20  FOREIGN  EXCHANGE 

for  it  is  obvious  that  if  Englishmen  receive  and  make  payment  to 
Americans  invariably  in  London  gold,  they  will  have  no  occasion 
to  exchange  London  gold  for  New  York  gold,  or  conversely. 

Various  Classes  of  Exchangers.— Ranged,  so  to  speak,  on  the 
one  side  of  this  New  York  market  are  all  who,  Hke  Barton  in  our 
example  (see  page  14),  are  in  possession  of  New  York  gold  which 
they  want  to  exchange  for  London  gold,  in  order  to  effect  pay- 
ment in  the  British  city,  provided  the  loss  they  will  sustain  on  the 
exchange,  if  any,  will  not  be  in  excess  of  the  cost  of  shipping  the 
required  amount  of  the  metal.  These  intending  exchangers  rep- 
resent the  current  demand  for  London  exchange.  They  may  be 
classified  under  the  following  five  heads: 

1.  Those  who  must  settle  in  London  for  merchandise,  ser- 

vices, or  securities  they  have  purchased  abroad. 

2.  Those  who  have  maturing  loans,  interest,  or  dividends  to 

pay  in  London  to  British  creditors  or  shareholders  in 
American  companies. 

3.  Capitalists  desiring  to  advance  loans  in  London. 

4.  Those  about  to  visit  England,  who  must  provide  them- 

selves with  London  gold  to  defray  the  expenses  of  their 
sojourn  abroad. 

5.  The  miscellaneous  group,  embracing  all  other  remitters, 

who  are  forwarding  funds  to  friends  and  relatives,  or 
on  other  minor  accounts. 

Turning  now  to  the  other  side  of  the  exchange  market,  we 
have  those  whose  position  is  similar  to  that  occupied  by  Smith  in 
our  illustration.  On  one  account  or  another  they  are  in  receipt 
of  London  gold,  which  they  desire  to  transfer  to  New  York,  pre- 
ferably by  sale  of  exchange,  if  that  method  is  cheaper  than  the 
actual  importation  of  the  metal.  Their  offerings  constitute 
the  current  supply  of  exchange,  and  they  may  be  divided  into  the 


SPOT  CABLE  EXCHANGE  21 

following  five  classes,  corresponding  to  the  five  classes  on  the 
demand  side  of  the  market: 

1.  Those  who  have  been  paid  in  London  for  merchandise, 

services,  and  securities  they  have  sold  on  the  other  side. 

2.  Those  who  have  received  payments  in  London  on  account 

of  dividends,  interest,  or  loans  fallen  due. 

3.  Those  who  have  obtained  loans  in  London  and  desire  to 

transfer  the  proceeds  to  New  York. 

4.  Travelers  and  other  visitors  from  England  who  require 

funds  on  this  side  for  spending  purposes. 

5.  All  others  who  are  in  possession  of  comparatively  small 

amounts  of  London  gold,  which  they  have  received  from 
friends  and  relatives  on  the  other  side,  or  on  sundry 
other  accounts. 

The  Exchange  Rate  at  a  Premium. — In  the  very  nature  of 
the  case,  against  every  sale  of  London  exchange  there  must  needs 
be  a  corresponding  purchase.  Still,  at  any  given  time  the  bidding 
for  exchange  may  exceed  the  amount  just  then  on  offer.  In 
other  words.  New  York  gold  may  be  offered  for  exchange  in 
greater  volume  than  London  gold.  This  happens  when  the  inter- 
city payments  are  running  on  balance  in  favor  of  London.  Pur- 
chases of  merchandise  made  abroad  by  American  merchants  may 
be  increasing  relatively  to  their  foreign  sales;  or  American  capi- 
talists may  have  been  induced  by  a  relative  advance  in  the  inter- 
est yield  on  London  loans  to  enlarge  their  advances  to  British 
borrowers;  or  again,  the  period  may  be  at  hand  when  American 
debtors  are  obliged  to  make  a  considerable  volume  of  payments 
to  their  British  creditors.  Any  one  or  several  of  these  and  the 
other  demand  items  may  overbalance  the  corresponding  items  in 
the  supply  list,  and  cause  the  prevailing  demand  for  exchange  to 
outrun  the  total  supply  available  at  the  moment.  Under  those 
circumstances  to  attract  additional  offerings  of  London  gold, 


22  FOREIGN  EXCHANGE 

would-be  buyers  of  exchange  are  compelled  to  mark  up  their 
prices  until  a  sufficient  supply  is  forthcoming  to  take  care  of  their 
requirements.  If  the  bidding  is  aggressive  enough,  the  rate  of 
exchange  will  sooner  or  later  be  driven  to  a  premium  above  the 
par  of  480  grains,  the  amount  of  which  will  measure  the  additional 
quantity  of  New  York  gold  that  must  be  given  in  exchange  for 
480  grains  of  London  gold  to  bring  into  the  market  the  volume  of 
London  gold  offerings  needed  to  match  the  existing  demand.  As 
the  rate  continues  upward,  it  assumes  a  position  increasingly  ad- 
verse to  New  York  and  favorable  to  London,  since  its  advance 
indicates  a  steady  depreciation  of  New  York  gold  with  respect  to 
London  gold  and  renders  more  imminent  the  loss  of  gold  by  New 
York  to  London  through  exportation. 

Sources  of  Exchange  Supplies. — What  are  the  likely  sources 
of  the  additional  supplies  of  London  exchange  necessary  to  bal- 
ance the  increasing  demand?  To  begin  with,  the  rising  premium 
on  the  rate  is  bound  to  stimulate  the  sale  of  American  merchan- 
dise to  British  buyers,  since  in  consequence  of  its  advance  Amer- 
ican merchants  stand  to  realize  larger  amounts  of  New  York  gold 
on  their  foreign  sales.  Greater  supplies  of  exchange  come  upon 
the  market,  therefore,  from  this  quarter.  At  the  same  time  the 
advancing  rate  increases  the  cost  of  British  goods  in  terms  of 
New  York  gold  to  American  buyers,  and  tends  to  curtail  their 
purchases,  with  the  result  that  their  buying  of  exchange  falls  off. 

Certain  speculative  transactions  in  exchange,  induced  by  a 
rise  in  the  rate,  also  contribute  to  the  equalization  of  the  demand 
and  supply.  While  in  the  long  run  they  are  not  as  powerful  in 
their  effect  as  the  factor  described  in  the  preceding  paragraph, 
they  respond  more  quickly  to  alterations  in  the  rate.  In  the 
first  place,  there  are  always  some  persons  in  New  York  in  posses- 
sion of  London  gold  who  have  deferred  converting  it  into  New 
York  gold  in  anticipation  of  obtaining  a  higher  rate  for  it.  When 
the  hoped-for  advance  materializes,  they  sell  their  exchange,  and 


SPOT  CABLE  EXCHANGE  23 

thus  add  to  the  total  supply.  On  the  other  hand,  there  are  others 
with  remittances  to  make  to  London  who,  when  an  advance  oc- 
curs in  the  rate,  postpone  their  purchases  of  exchange  as  long  as 
they  can,  in  the  hopes  that  the  rate  will  in  the  meantime  decline. 
Their  temporary  withdrawal  from  the  market  serves  to  diminish 
for  the  time  being  the  demand  for  exchange. 

Then,  too,  a  big  advance  in  the  rate  will  be  taken  by  some  as 
affording  an  opportunity  for  a  profitable  speculation  on  a  possible 
future  decline  in  the  rate.  They  will  either  sell  exchange  against 
loans  contracted  in  London  and  lend  the  funds  out  in  New  York, 
or  sell  exchange  for  future  delivery  in  a  manner  to  be  explained  in 
Chapter  IV.  If  the  rate  declines  when  they  are  obliged  to  remit 
to  London  against  the  maturity  of  their  obligations,  they  will  have 
realized  a  profit  on  the  operation. 

The  Exchange  Rate  at  a  Discount. — To  pass  now  to  the  op- 
posite situation,  when  the  demand  for  London  exchange  begins  to 
subside,  the  course  of  the  rate  is  reversed  and  the  premium  grad- 
ually declines,  since  intending  sellers  are  now  forced  to  lower  their 
offering  prices  to  dispose  of  their  supplies.  If  this  tendency  con- 
tinues, the  premium  in  time  disappears  entirely  as  the  rate 
touches  par,  which  quotation  will  attest  the  fact  that  the  inter- 
city payments  are  equalized  at  the  moment.  If  the  balance  of  / 
payments  turns  definitely  in  favor  of  New  York  and  the  supply  of 
exchange  exceeds  the  demand,  the  quotation  drops  to  a  discount 
below  par.  On  its  downward  course  the  rate  moves  in  favor  of 
New  York  and  against  London,  since  it  registers  a  steady  appre- 
ciation of  New  York  gold  as  regards  London  gold,  and  enhances 
the  possibility  of  a  movement  of  the  metal  setting  in  from  London 
to  New  York. 

The  additional  demand  necessary  to  balance  the  growing  sup- 
ply emanates  from  sources  which  are  the  exact  counterparts  of  y 
those  from  which  proceed  the  extra  supplies  needed  to  match  an 
increasing  demand.     As  the  declining  rate  means  lower  prices  in 


(/ 


24  FOREIGN  EXCHANGE 

New  York  gold  on  all  purchases  and  sales  of  merchandise  between 
the  United  States  and  England,  purchases  from  England  will  in- 
crease and  engender  a  stronger  demand  for  exchange,  while  sales 
to  England  will  fall  off  and  result  in  a  contraction  in  offerings  of 
exchange.  The  lower  rate  will  also  encourage  immediate  buying 
of  exchange  by  those  who  have  settlements  to  make  in  London  in 
the  near  future,  while  it  will  tend  to  check  immediate  selling,  as 
some  intending  sellers  will  prefer  to  wait  for  a  possible  recovery 
in  the  rate. 

Lastly,  the  drop  in  the  rate  may  occasion  a  demand  from  some 
who  are  bent  on  speculating  on  a  future  advance  in  the  quotation. 
They  will  purchase  exchange  with  money  borrowed  in  New  York 
and  loan  out  the  funds  in  the  London  market.  Subsequently, 
when  their  advances,  mature,  they  will  recall  their  funds  by 
selling  exchange,  and  at  the  same  time  retire  their  borrowings 
in  New  York.  They  may  also  speculate  by  purchasing  ex- 
change for  future  delivery.  In  either  case,  if  the  exchange  rate 
advances  in  the  interval,  their  speculation  will  have  yielded  them 
a  profit. 

The  Gold  Export  Point  of  the  Spot  Cable  Rate. — As  has  been 
repeatedly  remarked,  shipment  is  substituted  for  exchange  in  the 
transfer  of  funds  between  the  two  centers  when  the  loss  on  the 
latter  exceeds  the  cost  of  consigning  the  metal.  From  this  it  may 
at  once  be  inferred  that  the  rate  cannot  draw  away  from  par  in- 
definitely in  either  direction.  As  a  matter  of  fact,  its  fluctuations 
are  normally  restricted  to  a  narrow  range  extending  above  and 
below  par,  the  limits  of  which  are  fixed  approximately  by  the  cost 
of  shipment,  including  a  certain  interest  loss.  These  limits  are 
known  by  the  names  of  "gold  export  point''  and  "gold  import 
point,"  or  by  the  single  designation  of  "specie  points,"  which 
covers  them  both.  We  have,  therefore,  to  ascertain  the  man- 
ner in  which  these  points  are  determined  under  a  given  set  of 
conditions. 


SPOT  CABLE  EXCHANGE  25 

The  upper  Limit. — Let  us  first  fix  our  attention  on  the  upper 
limit,  the  gold  export  point.  When  the  rate  of  exchange  is  ruling 
at  a  premium,  it  is  adverse  to  the  buyer  of  exchange,  as  he  is 
obliged  to  surrender  a  greater  amount  of  gold  in  New  York  than  he 
obtains  in  London.  If,  for  example,  the  rate  is  481  grains^  he 
loses  a  grain  on  every  480  grains  he  gets  in  London.  And  as  the 
rate  advances  and  the  premium  increases,  his  loss  grows  corre- 
spondingly greater.  Eventually,  if  the  rate  continues  to  rise,  it  y 
reaches  a  level  at  which  the  purchase  of  exchange  is  as  expensive 
as  the  shipment  of  gold.  The  point  at  which  these  two  ways  of 
remitting  to  London  exactly  balance  is  the  gold  export  point. 
The  moment  the  rate  passes  beyond  this  point,  shipment  becomes 
cheaper  than  the  purchase  of  exchange  and  tends  to  displace  it  as 
a  means  of  remitting  to  London.  The  resulting  decline  in  the 
demand  for  exchange  prevents  any  further  advance  in  the  rate. 
The  actual  limit  of  the  rate's  advance  is,  then,  just  beyond  the^ 
export  point.  If  we,  therefore,  define  the  position  of  the  export 
point,  we  shall  have  approximately  determined  the  maximum  dis- 
tance the  rate  can  move  above  par. 

A  Sample  Case. — To  this  end  let  us  take  a  concrete  example. 
Suppose  the  rate  for  spot  cables  is  482  grains,  and  ten  days  are 
required  to  ship  and  lay  down  gold  in  London,  which  period  of 
time  we  shall  hereafter  allude  to  as  the  "shipping  period."  Sup- 
pose, further,  that  the  London  interest  rate  is  4%  per  annum,  or, 
on  the  basis  of  360  days  to  the  year,  at  the  flat  rate  of  -g-J-g-  for  the 
shipping  period.  Assume  now  that  a  person  in  New  York  has  a 
debt  to  pay  immediately  in  London.  If  he  purchases  a  spot  cable 
at  the  rate  of  482  grains,  it  will  obviously  cost  him  an  extra  2 
grains  of  New  York  gold  to  discharge  480  grains  of  his  debt. 

He  will  first  stop  to  figure,  however,  whether  he  will  not  do 
better  by  shipping  gold.     Inasmuch  as  his  consignment  will  not 

3  Unless  expressly  stated  to  the  contrary,  it  will  be  understood  that  the 
first  system  of  quotation  is  used  in  all  the  illustrations  to  follow. 


26  FOREIGN  EXCHANGE 

arrive  in  London  until  lo  days  after  his  obligation  is  due,  he  will 
obviously  have  to  borrow  in  London  for  the  interval,  in  case  he 
makes  a  shipment.  The  interest  he  will  pay  on  every  480  grains 
of  the  loan  will  amount  to  yV  ^^  ^  grain  (^-^  of  480) ;  and  as  it 
will  not  be  offset  by  any  interest  accrual  on  the  gold  while  in 
transit,  he  will  have  to  set  it  down  for  a  total  loss.  To  meet  the 
loan  at  maturity,  he  must,  therefore,  ship  48oyV  grains  for  every 
480  grains  he  borrows.  Thus,  in  addition  to  sustaining  a  loss  of 
interest  at  the  London  rate  on  480  grains  for  the  shipping  period, 
he  will  be  obliged  to  bear  the  expense  of  shipping  480  grains,  plus 
the  above  amount  of  interest.  Suppose  this  transportation  cost, 
which  includes  such  items  as  freight,  marine  insurance,  packing, 
and  cartage,  amounts  to  lyV  grains,  so  that  when  added  to  the 
interest  loss  it  exactly  equals  2  grains.  In  that  event,  he  will 
have  to  devote  482  grains  of  his  New  York  gold  to  the  payment  of 
480  grains  of  his  maturing  London  debt.  His  conclusion  is, 
therefore,  that  gold  shipment  is  precisely  as  expensive  as  the 
purchase  of  exchange.  Hence  482  grains  is  the  gold  export  rate 
at  the  moment  for  spot  cable  transfers. 

Calculating  the  Gold  Export  Point. — We  may  lay  down  the 
general  proposition,  then,  that  the  spot  cable  rate  is  at  the  gold 
/  export  point  when  the  premium  on  it  is  equal  to  the  sum  of  the 
interest  at  the  London  rate  on  the  par  of  480  grains  for  the  ship- 
ping period,  and  the  expense  of  shipping  a  quantity  of  gold 
amounting  to  480  grains,  plus  the  aforementioned  amount  of 
interest.  To  reduce  this  formula  to  an  algebraic  expression,  if 
f  (represents  the  gold  export  premium,  /  the  London  rate  of  in- 
terest for  the  shipping  period,  and  e  the  number  of  grains  it  costs 
to  ship  480  grains  to  London,  p  equals  (480  X  /)  +  e(i  +  /). 
Furthermore,  since  (480  X  /)  +  e(i  +  /)  equals  e  +  /(480  +  e), 
the  gold  export  premium  is  also  equal  to  the  expense  of  shipping 
480  grains  to  London,  plus  interest  at  the  London  rate  for  the  ship- 
ping period  on  the  sum  of  par  and  the  above  transportation  cost. 


SPOT  CABLE  EXCHANGE  2^ 

Finally,  the  gold  export  rate,  or  (480  +  p),  being  equal  to  (480 
4-  e)  +  /(480  +  e),  is,  therefore,  equal  to  (480  -\-  e)  (i  +  /), 
that  is,  to  the  sum  of  par  and  the  cost  of  shipping  480  grains,  plus 
interest  on  this  sum  at  the  London  rate  for  the  shipping  period. 

Varying  Gold  Export  Points. — The  transportation  charges 
and  interest  loss  on  gold  consignments  vary,  however,  with  differ-  / 
ent  individuals.  Each  has,  therefore,  his  own  gold  export  point. 
But  the  actual  limit  of  the  exchange  rate's  advance  is  determined 
by  the  export  point  of  those  who  can  ship  to  and  borrow  in  Lon-  ^ 
don  most  cheaply.  They  are  usually  bankers  in  the  enjoyment 
of  first-class  credit  with  London  banks  and  possessing  special 
facilities  for  shipping  on  a  large  scale.  Inasmuch  as  their  export 
point  is  the  lowest,  they  can  begin  to  ship  when  it  is  still  unprofit- 
able for  others  to  do  so.  In  fact,  they  have  a  monopoly  of  the 
exporting,  as  their  consignments  are  large  enough  to  prevent  the 
rate  from  exceeding  the  export  points  of  other  remitters.  For, 
by  offsetting  their  consignments  with  sales  of  exchange,  as  is 
usually  their  practice,  they  can  ship  indefinitely,  regardless  of 
whether  they  have  any  obligations  to  meet  in  London  or  not,  so 
long  as  the  rate  remains  above  their  export  point.  Such  opera- 
tions are  in  reality  arbitrage  transactions,  being  undertaken 
simply  for  the  profit  they  offer.  Thus  a  banker  sells  spot  cables 
against  a  loan  he  obtains  in  London,  and  out  of  the  proceeds  con- 
signs enough  gold  to  cover  the  loan  at  maturity.  If  his  export 
point  at  the  moment  is  482  grains  and  he  markets  the  cables  at 
the  rate  of  482  J  grains,  he  makes  a  profit  of  ^  of  a  grain  of  New 
York  gold  on  every  480  grains  of  cables  he  sells.  The  increased 
supply  of  exchange  resulting  from  such  sales  by  arbitrageurs  keeps 
the  rate  below  the  export  point  of  other  less  favorably  placed  re- 
mitters, who  continue  to  purchase  exchange. 

The  Gold  Import  Point  of  the  Spot  Cable  Rate.— The  gold 
import  point  for  spot  cables  marks  the  maximum  discount  to 


28  FOREIGN  EXCHANGE 

which  the  rate  can  under  normal  conditions  decline.  When  the 
rate  is  quoted  under  par,  it  is  unfavorable  to  sellers  of  exchange, 
since  the  amount  of  gold  they  then  obtain  in  New  York  is  less 
than  the  quantity  they  give  up  in  London.  If,  for  example,  the 
rate  is  479  grains,  they  lose  a  grain  on  every  480  grains  of  exchange 
they  sell;  and  as  the  rate  is  marked  down  farther,  their  loss  in- 
creases correspondingly.  If  the  quotation  keeps  on  receding,  it 
eventually  touches  the  gold  import  point,  when  the  loss  on  the 
sale  of  exchange  becomes  precisely  equal  to  the  cost,  including 
the  loss  of  interest,  of  bringing  gold  over  from  London.  There- 
after, any  further  drop  in  the  rate  renders  importation  the  more 
advantageous  method  of  withdrawing  funds  from  London,  and 
shipment  is  consequently  substituted  for  the  sale  of  exchange. 
The  resulting  reduction  in  the  supply  of  exchange  prevents  any 
further  decline  in  the  rate,  which  remains  just  far  enough  below 
the  import  point  to  induce  gold  importation. 

To  determine  the  position  of  the  gold  import  rate,  let  us  take 
the  case  of  a  person  in  New  York  who  is  in  possession  of  gold  in 
London,  but  has  immediate  need  of  it  in  New  York,  say,  to  pay  a 
maturing  debt.  Assume  that  478  grains  is  the  exchange  rate, 
10  days  are  required  to  ship  gold  from  London,  and  the  interest 
rate  in  New  York  is  6%  per  annum,  or  ^^  for  the  importing  pe- 
riod. If  he  effects  the  transfer  of  his  gold  by  sale  of  exchange,  he 
sustains  a  loss  of  2  grains  on  every  480  grains  he  surrenders  in 
London,  as  he  gets  only  478  grains  in  New  York.  On  the  other 
hand,  if  he  orders  the  gold  to  be  shipped,  he  must  anticipate  its 
arrival  by  contracting  a  loan  in  New  York  for  the  amount  of  his 
debt.  Interest  on  every  478  grains  of  the  loan  at  the  flat  rate  of 
^f^  will  amount  to  |f|  of  a  grain,  which  will  be  a  complete  loss  to 
the  shipper,  as  the  gold  in  transit  will  yield  him  no  interest  return 
to  offset  it.  He  is,  therefore,  obliged  to  import  47HU  grains 
against  every  478  grains  he  borrows.  If  the  expense  of  importing 
this  amount  of  the  metal  is  i  gVir  grains  of  London  gold,  so  that 
the  total  cost,  including  the  interest  loss,  will  amount  to  exactly 


SPOT  CABLE  EXCHANGE  29 

2  grains,  gold  importation  is  at  parity  with  the  sale  of  exchange 
at  478  grains,  which  rate  is  accordingly  the  gold  import  point. 

Calculating  the  Gold  Import  Point. — The  spot  cable  rate  is  thus 
at  the  gold  import  point  when  its  discount  is  equal  to  the  interest 
at  the  New  York  rate  on  the  exchange  quotation  for  the  importing 
period,  plus  the  expense  of  importing  a  quantity  of  gold  amount- 
ing; to  the  sum  of  the  quotation  and  the  above  mentioned  amount 
of  interest.  To  express  this  in  algebraic  form,  if  q  denotes  the 
gold  import  rate,  i  the  flat  rate  of  interest  in  New  York  for  the 
importing  period,  and  E  the  cost  of  importing  480  grains,  the  dis- 
count on  the  gold  import  rate,  or  (480  —  g),  equals 

^   ,  £  X  g(i  +  i) 
(^X^)  + ^8^ 

As  this  latter  expression  in  turn  equals 

the  gold  import  discount  may  also  be  given  as  amounting  to  the 
expense  of  importing  a  quantity  of  gold  equal  to  the  gold  import 
quotation,  plus  interest  at  the  New  York  rate  for  the  importing 
period  on  the  sum  of  the  quotation  and  the  above  transportation 
expense.    Finally,  since  (480  —  q)  equals 

q  equals  480^ 

(480  +  £)(!  +  i) ' 

That  is  to  say,  the  gold  import  rate  equals  the  square  of  the  par  of 
480  grains  divided  by  the  following  quantity:  the  sum  of  par  and 
expense  of  importing  480  grains,  plus  interest  on  this  sum  at  the 
New  York  rate  for  the  importing  period. 


J 


30  FOREIGN  EXCHANGE 

As  in  the  case  of  gold  exportation,  it  is  only  bankers  who  can 
ordinarily  import  the  metal  to  advantage.  Inasmuch  as  they 
incur  the  least  expense  and  interest  loss  on  shipments,  their  im- 
port point  is  the  highest,  and  they  can,  therefore,  bring  in  the 
metal  when  it  is  still  unprofitable  for  others  to  do  so.  Their  im- 
portations do  not,  as  a  rule,  represent  the  withdrawal  of  funds 
from  London,  but  are  undertaken  in  conjunction  with  offsetting 
purchases  of  exchange  with  the  object  of  reaping  the  difference 
between  the  import  point  and  the  current  exchange  quotation. 
The  exchange  is  bought  with  loans  contracted  in  New  York, 
which  are  paid  off  on  the  arrival  of  the  gold  from  London.  The 
increased  demand  for  exchange  caused  by  the  arbitrage  operations 
tends  to  hold  the  rate  above  the  gold  import  points  of  others, 
who  find  it  more  advantageous  to  sell  exchange  in  withdrawing 
funds  from  London. 

Both  Specie  Points  Variable. — We  have  thus  fixed  the  ap- 
proximate limits,  above  and  below  par,  between  which  the 
movements  of  the  spot  cable  rate  are  confined.  Within  this  range 
the  rate  swings  up  and  down  in  answer  to  the  changing  conditions 
of  demand  and  supply.  But  obviously,  since  these  specie  points 
are  determined  by  variable  factors,  they  must  needs  be  variable 
themselves.  The  expense  of  shipping  in  normal  times  seldom 
changes  to  any  appreciable  extent.  But  interest  rates  in  London 
and  New  York  are  subject  to  frequent  fluctuations,  which  cause 
corresponding  shifts  in  the  specie  points.  Moreover,  the  time 
necessary  to  ship  gold  from  one  center  to  the  other  varies 
with  the  speed  of  the  steamers  and,  accordingly,  the  posi- 
tions of  the  specie  points  also  change  with  this  factor.  In 
short,  the  specie  points  draw  away  from  the  par  of  480  grains 
as  the  expense  of  carriage,  the  interest  rate  in  the  center  to 
which  shipment  is  contemplated,  and  the  length  of  the  trans- 
portation period  increase;  and  draw  nearer  to  par  as  these  fac- 
tors decrease. 


SPOT  CABLE  EXCHANGE  3I 

Minor  Factors  Affecting  the  Specie  Points. — To  avoid  en- 
cumbering the  illustrations  with  too  much  detail,  certain  minor 
points  were  omitted.  Briefly  summarized,  these  points  are  as 
follows: 

1.  No  distinction  was  made  in  our  illustrations  between  gold 
coin  and  gold  bullion,  but  every  piece  of  the  metal,  in  whatever 
form  it  appeared,  was  assumed  to  be  of  exactly  the  weight  it  pur- 
ported to  be,  and  as  acceptable  as  any  other  of  equal  weight.  But 
in  practice  coins  become  abraded  from  current  use  in  circulation, 
and  unless  the  loss  exceeds  the  limit  prescribed  by  law,  creditors 
in  the  country  of  their  issue  are  compelled  to  accept  them  as 
though  they  had  their  full  original  weight.  But  abroad,  such  coins 
as  a  rule  are  taken  only  at  their  actual  weight.  A  loss  is,  there- 
fore, sustained  in  exporting  them  which,  for  all  practical  purposes, 
may  be  looked  upon  as  an  added  expense  of  shipment. 

2.  In  the  importing  country,  the  gold  coin  or  bullion  may  be 
sold  (exchanged  for  promises  of  banks  in  the  form  of  deposits  to 
pay  gold  on  demand)  at  a  slight  discount,  which  represents  the 
interest  the  buyers  demand  for  the  few  days  the  metal  is  unavail- 
able while  it  is  being  minted  into  coins  of  the  realm.  Again,  such 
loss  may  be  regarded  as  increasing  the  transportation  cost. 

3.  The  metal  must  be  secured  a  few  days  in  advance  of  the 
day  of  consignment  in  order  to  prepare  it  for  shipment,  and  its 
delivery  in  the  other  center  is  usually  delayed  a  few  days  while  it 
is  weighed  and  assayed.  Account  may  be  taken  of  both  these 
brief  periods  by  merely  regarding  them  as  extending  the  total 
period  of  shipment  and  increasing  the  interest  loss. 

Specie  Points  When  Rates  Are  Expressed  in  Foreign  Gold. — 

We  have  yet  to  discuss  the  calculation  of  the  specie  points  under 
the  second  system  of  quotation.     From  the  equation 

482  grains  of  New  York  gold      480  grains  of  New  York  gold 
480  grains  of  London  gold        4783^!  r  grains  of  London  gold 


32  FOREIGN  EXCHANGE 

it  is  evident  that  when  the  gold  export  rate,  quoted  in  terms  of 
New  York  gold,  is  482  grains,  its  equivalent  rate  in  terms  of  Lon- 
don gold  is  478^1  J-  grains.  Accordingly,  the  figure  denoting  the 
export  rate  under  the  second  system  of  quotation  is  below  the 
par  of  480  grains.  Now,  precisely  in  the  way  in  which  it  was 
shown  that  the  premium  of  the  gold  export  rate  expressed  in  New 
York  gold  is  equal  to  the  shipping  expense  on  480  grains,  plus 
interest  at  the  London  rate  for  the  shipping  period  on  the  sum  of 
par  and  this  expense,  it  can  be  demonstrated  that  the  difference 
between  par  and  the  export  rate  expressed  in  London  gold  is 
equal  to  the  cost  of  shipping  an  amount  of  gold  equal  to  the  export 
rate,  plus  interest  at  the  London  rate  for  the  shipping  period  on 
the  sum  of  the  export  rate  and  the  transportation  charges.  "*  Under 
both  systems  of  quotation,  then,  the  calculation  of  the  export  rate 
•^  is  based  on  the  term  of  the  ratio  of  exchange  which  refers  to  London 
gold,  on  par  in  the  one  case  and  on  the  quoted  figure  in  the  other. 
Turning  now  to  the  gold  import  rate;  if  it  is  478  grains  when 
referring  to  New  York  gold,  it  is  482^^  grains  when  referring  to 
London  gold,  since  the  ratio 

478  grains  of  New  York  gold 
480  grains  of  London  gold 
is  equal  to  the  ratio 

480  grains  of  New  York  gold 
482^1-5-  grains  of  London  gold 

From  this  it  is  apparent  that  the  figure  indicating  the  gold  import 
rate  under  the  second  system  of  quotation  stands  above  par.     By 

4  Inasmuch  as  the  gold  export  rate  expressed  in  terms  of  New  York  gold  is 

(480  +  e)  (i  +7)  grains  (see  page  27),  it  is  -^—z — ,     .  . — r—p:  grains  when 

{400  -jr  e)  U  -r  -i) 

expressed  in  terms  of  London  gold,  as 

(48o  +  e)(i+/)  480 


480  480" 

(480  +  e)  (I  +  /) 


SPOT  CABLE  EXCHANGE  33 

the  same  method  by  which  the  formula  for  the  gold  import  dis- 
count under  the  first  system  of  quotation  was  computed,  it  can 
be  demonstrated  that  the  difference  between  the  gold  import  rate 
and  par  under  the  second  system  of  quotation  is  equal  to  the  ex- 
pense of  shipping  480  grains,  plus  interest  at  the  New  York  rate 
for  the  shipping  period  on  the  sum  of  par  and  the  shipping 
charges.  ^  In  the  case  of  the  gold  import  rate,  the  basis  of  calcu- 
lation is  the  term  of  the  ratio  of  exchange  which  refers  to  New 
York  gold,  the  quoted  figure  under  the  first  system  of  quotation, 
and  par  under  the  second  system  of  quotation. 


s  As  the  gold  import  rate  expressed  in  New  York  gold  equals ^ — 


(48o+£)(i+0 

grains  (see  page  29),  it  is  equal  to  (480  +E)  (i  +  i)  grains  when  expressed  in 
London  gold,  since 

480^ 
(480  +  E)  (I  +i)  480 


480  (480  +£)(!+  *) 


CHAPTER  III 

THE  DUAL  SYSTEM  OF  EXCHANGE 

An  Exchange  Market  in  Both  Cities. — There  are  no  two  cities 
in  the  world  of  any  standing  as  financial  centers  which  settle  the 
mutual  transactions  of  their  respective  countries  exclusively  by 
the  dehvery  of  gold  in  one  of  them,  as  has  been  assumed  in  the 
preceding  chapter.  On  the  contrary,  in  every  instance  the  one 
city  in  some  transactions,  and  the  other  city  in  other  transactions, 
is  selected  as  the  place  of  delivery.  As  has  already  been  pointed 
,  out,  the  question  of  where  the  gold  is  to  be  tendered  in  payment  is 
in  every  case  decided  between  the  two  parties  concerned.  It 
follows  that  people  in  both  countries  have  occasion  to  exchange 
with  each  other  gold  in  the  one  city  for  gold  in  the  other.  There 
is  thus  in  operation  between  the  two  places  what  may  be  char- 
acterized as  a  dual  system  of  gold  exchange.  This  system  is 
analyzed  in  the  present  chapter  so  far  as  the  spot  cable  transfer 
is  concerned. 

As  between  New  York  and  London,  payment  in  the  great  pro- 
portion of  cases  is  stipulated  in  the  latter  city,  and  the  bulk  of 
the  gold  exchanging  between  these  cities  is,  accordingly,  arranged 
in  New  York,  between  those  who  are  paid  in  London  and  those 
who  have  undertaken  delivery  there.  Still,  the  number  of  inter- 
city settlements  made  by  the  delivery  of  gold  in  New  York  is  not 
inconsiderable  in  the  aggregate,  and  there  is  a  corresponding 
volume  of  gold  exchanges  taking  place  in  London,  between  those 
who  are  in  receipt  of  gold  in  New  York  and  those  who  have  en- 
to  pay  it  there. 


Unity  of  the  Two  Markets. — Whether  the  exchange  transac- 
tions are  entered  into  in  the  one  or  the  other  city,  they  are  identi- 

34 


THE  DUAL  SYSTEM  OF  EXCHANGE  .         35 

cal  in  nature,  for  in  both  cases  the  things  exchanged  are  respec- 
tively the  same,  namely,  gold  in  New  York  and  gold  in  London. 
Moreover,  the  two  cities  practically  constitute  a  single  exchange 
market,  for  by  means  of  cable  communication  Americans  are 
able  to  contract  exchanges  in  London  and  Englishmen  to  con- 
tract exchanges  in  New  York,  with  almost  the  same  facility,  and 
with  no  appreciably  greater  expense  where  the  amounts  are  large, 
as  in  their  respective  home  markets.  Indeed,  the  big  exchangers 
in  each  city,  the  foreign  exchange  bankers,  make  it  a  practice  to 
keep  themselves  constantly  informed  by  cable  on  the  rate  of  ex-  u^ 
change  prevailing  in  the  other  city,  and  to  accomplish  their  ex- 
changes in  the  market  which  offers  the  more  attractive  rate.  As 
will  shortly  be  seen,  this  constant  readiness  to  take  advantage  of 
any  existing  difference  between  the  rates  in  the  two  centers  has  a 
tendency  to  obliterate  the  discrepancy  and  virtually  to  merge  the ' 
markets  into  one.  Nor  need  the  exchangers  be  residents  of  either 
America  or  Great  Britain.  On  the  contrary,  they  may  be  located 
in  any  quarter  of  the  globe  and  still  be  able  to  effect  the  exchange 
of  New  York  gold  for  London  gold  almost  as  easily  as  though  they 
were  present  in  person  in  the  one  or  the  other  city,  if  they  are  in 
immediate  touch  with  either  center  by  cable. 

Two  Distinct  Viewpoints. — Although  the  exchanges  are  iden- 
tical in  nature,  the  two  cities  regard  them  from  opposite  view- 
points. This  difference  of  viewpoint,  coupled  with  a  possible 
difference  in  the  manner  of  quoting  rates  in  the  two  places,  is  one 
of  the  commonest  causes  of  mental  confusion  on  the  general  sub- 
ject of  foreign  exchange.  As  already  remarked,  it  is  a  universal 
custom  growing  out  of  a  perfectly  natural  propensity  for  each  city 
to  look  upon  domestic  gold,  given  or  received  in  exchange,  as  the 
price  that  is  paid,  and  the  foreign  gold  as  the  commodity  that 
is  purchased.  Accordingly,  while  in  New  York,  London  gold  is 
regarded  as  the  commodity  or  "exchange,"  and  New  York  gold 
the  price,  in  London,  New  York  gold  is  regarded  as  the  com- 


V. 


36     •      .  FOREIGN  EXCHANGE 

modity,  or  "exchange/'  and  London  gold  the  price.  The  ex- 
change of  New  York  gold  for  London  gold  is,  therefore,  viewed  as 
a  purchase  of  London  exchange  when  negotiated  in  New  York, 
and  as  a  sale  of  New  York  exchange  when  negotiated  in  London; 
and  vice  versa,  the  exchange  of  London  gold  for  New  York  gold 
is  looked  upon  as  a  sale  of  London  exchange  when  contracted  in 
New  York,  and  a  purchase  of  New  York  exchange  when  con- 
tracted in  London. '  From  this  it  is  apparent  that  the  purchase 
of  London  exchange  in  New  York  is  identical  with  the  sale  of 
New  York  exchange  in  London;  and  the  sale  of  London  exchange 
in  New  York  is  identical  with  the  purchase  of  New  York  exchange 
in  London. 

Manner  of  Quoting  Rates. — As  regards  the  manner  of  quot- 
ing rates  in  the  two  centers,  we  have  already  alluded  to  the  fact 
that  it  is  the  usual  practice  in  the  various  financial  centers  of  the 
world  to  express  rates  of  exchange  in  terms  of  domestic  gold,  or 
in  accordance  with  what  we  have  elected  to  call  the  first  system 
of  quotation.  While  this  is  the  method  actually  applied  to  Lon- 
don exchange  in  New  York,  in  London  the  opposite  mode  is  used, 
the  rates  for  New  York  exchange  being  denoted  in  terms  of  New 
York  gold,  i.e.,  according  to  the  second  system  of  quotation. 
We  shall  assume  in  the  theoretical  part  of  our  discussion,  how- 
ever, the  use  of  the  first  system  of  quotation  in  London  as  well  as 
in  New  York,  except  when  we  give  special  attention  to  the  second 
system. 

Assuming,  then,  that  the  rates  in  both  cities  are  expressed  in 
domestic  gold,  it  is  clear  that  the  figures  by  which  they  are  indi- 


*  London  and  New  York  exchange  are  referred  to,  with  even  greater  fre- 
quency, as  "sterling"  and  "dollar  exchange"  respectively,  terms  borrowed 
from  the  names  of  the  monetary  units  employed  in  the  two  countries.  But  in 
view  of  our  assumption  of  a  hypothetical  unit  common  to  both  countries,  it 
is  better  to  postpone  the  use  of  these  expressions  to  the  last  three  chapters, 
where  we  shall  deal  with  the  actual  units  employed. 


THE  DUAL  SYSTEM  OP  EXCHANGE  37 

cated  refer  to  different  things,  to  New  York  gold  in  the  case  of  the 
New  York  rate,  and  to  London  gold  in  the  case  of  th  e  London 
rate.  The  quotations  are,  therefore,  bound  to  differ  even  though 
the  ratios  they  represent  may  be  exactly  equal.  To  illustrate, 
if  the  rate  in  New  York  for  spot  cable  transfers  on  London  is  481 
grains,  or  expressed  in  full, 

481  grains  of  New  York  gold 
480  grains  of  London  gold 

the  equivalent  rate  in  London  for  spot  cables  on  New  York  is 
4797  ST  grains,  as  the  ratio  it  represents,  namely, 

480  grains  of  New  York  gold 

• J 

479:j^Y  grains  of  London  gold 

is  equal  to  the  ratio  of  exchange  in  New  York. 

When  the  spot  cable  rates  in  the  two  centers  are  mutually 
equivalent,  they  are  said  to  be  ''at  parity  "  with  each  other,  and 
the  par  of  480  grains  is  the  mean  proportional  of  the  figures  ex- 
pressing them.  In  this  relative  position  they  are  quoted  one  at  a 
premium  and  the  other  at  a  discount.  The  premium  in  the  one 
case  is  merely  the  converse  of  the  discount  in  the  other,  although 
it  bears  a  slightly  higher  proportion  to  par  than  the  discount  does. 

Exchanges  Between  People  of   Different  Countries. — The 

greater  part  of  the  exchanges  in  the  two  cities  are  negotiated  be- 
tween residents  of  their  respective  countries.  In  New  York  the  ex- 
changes are  performed  mostly  between  Americans,  and  in  London 
between  Englishmen.  But,  as  noted  above,  cable  communica- 
tion between  the  two  cities  renders  possible  the  negotiation  of 
exchange  in  either  place,  between  Americans  on  the  one  hand  and 
Englishmen  on  the  other.  Thus,  an  American  desiring  to  effect 
an  exchange  of  New  York  gold  for  London  gold  can  cable  an  order 
to  his  London  agent  to  sell  New  York  exchange  on  his  behalf;  or 


3B  FOREIGN  EXCHANGE 

if  he  wants  to  make  the  reverse  exchange,  of  London  gold  for 
New  York  gold,  he  can  direct  his  agent  to  purchase  New  York 
exchange.  In  the  same  manner  an  Englishman  can  execute  an 
exchange  of  London  gold  for  New  York  gold  by  cabling  his  agent 
in  New  York  to  sell  London  exchange  for  his  account;  or  if  he 
wishes  to  exchange  New  York  gold  for  London  gold,  he  can  in- 
struct his  agent  to  purchase  London  exchange. 

The  particular  market  which  exchangers  in  either  city  will 
J  select  for  contracting  their  trades  will  naturally  depend  upon  the 
relative  position  of  the  rates  in  both.  If  parity  prevails  between 
the  quotations,  they  will  perform  their  exchanges  at  home,  as 
they  have  then  nothing  to  gain  by  resorting  respectively  to  the 
foreign  market.  Americans  will  buy  and  sell  London  exchange 
to  each  other  in  New  York,  and  Englishmen  will  buy  and  sell 
New  York  exchange  to  each  other  in  London.  But  when  a  differ- 
ence arises  between  the  rates,  in  consequence  of  which  London 
gold  is  cheaper  in  London  than  in  New  York,  and,  conversely. 
New  York  gold  is  cheaper  in  New  York  than  in  London,  some 
Americans  (foreign  exchange  bankers),  who  are  aware  of  the  dis- 
parity and  possess  the  requisite  facilities  for  taking  quick  advan- 
tage of  it,  will  remit  to  London  by  selling  New  York  exchange  in 
London  rather  than  by  buying  London  exchange  in  New  York; 
and  at  the  same  time  some  Englishmen  (foreign  exchange  bank- 
ers) will  remit  to  New  York  by  selling  London  exchange  in  New 
York  instead  of  buying  New  York  exchange  in  London.  On  the 
other  hand,  when  the  rates  exhibit  the  reverse  disparity,  whereby 
London  gold  is  dearer  in  London  than  in  New  York,  and  vice 
versa.  New  York  gold  is  dearer  in  New  York  than  in  London, 
some  Americans  will  withdraw  their  funds  from  London  by  pur- 
chasing New  York  exchange  in  London  instead  of  selling  London 
exchange  in  New  York,  while  some  Englishmen  will  withdraw 
their  funds  from  New  York  by  buying  London  exchange  in  New 
York  in  lieu  of  selling  New  York  exchange  in  London.  But  this 
exchanging  between  residents  of  different  countries,  when  the 


THE  DUAL  SYSTEM  OP  EXCHANGE 


39 


rates  are  unequal,  is  self-terminating,  since,  as  we  shall  presently  u/ 
see,  it  tends  to  equalize  the  rates  and  remove  the  cause  which 
gives  rise  to  it. 


Graphic  Illustration  of  the  Two  Exchange  Markets.— Before 

passing  to  an  examination  of  the  tendency  of  the  rates  to  make  for 
mutual  parity,  we  shall  study  for  a  moment  the  accompan5dng 


NEW  YORK 


Payers  of 
London  gold 


Payees  of 
London  gold 


LONDON 


Payees  of 
London  gold 


D^ 


diagram,  representing  the  relationships  between  the  various  classes 
of  persons  in  the  two  cities  who  directly  or  indirectly  figure  in  the 
exchanges.  A  thorough  acquaintance  with  the  diagram  will  en- 
able us  to  visualize  more  fully  the  simultaneous  operation  of  both 
exchange  markets,  and  to  have  a  better  appreciation  of  the  man- 
ner in  which  they  are  correlated  and  tend  virtually  to  become  one. 
The  four  rectangles  on  each  side  of  the  figure  are  self-explanatory. 
They  represent  the  several  groups  of  persons  in  each  city  who  in 
one  capacity  or  another  take  part  in  the  exchanges.    The  rela- 


40  FOREIGN  EXCHANGE 

tionships  between  payers  of  the  one  center  and  payees  of  the  other 
are  indicated  by  the  dotted  Hnes.  Those  who  actually  enter  into 
exchange  dealings  with  each  other,  either  in  the  same  city  or 
between  the  two  cities,  are  connected  by  the  broken  lines,  the 
arrow-heads  of  which  indicate  the  direction  in  which  exchange 
is  sold.  The  solid  lines  represent  the  direction  in  which  gold 
changes  hands  at  both  centers  in  consequence  of  the  exchanges. 

Let  us  first  examine  the  operation  of  the  New  York  market 
so  far  as  the  exchanges  conducted  between  Americans  are  con- 
cerned. A  payers  of  New  York  have  engaged  to  deliver  gold  in 
London  to  D'  payees  of  London.  Concurrently  B  payees  of  New 
York  are  acquiring  gold  in  London  from  C  payers  of  London.  A 
and  B  thereupon  exchange  their  respective  gold  holdings  in  New 
York  and  London  at  the  existing  market  rate.  The  transactions 
are  completed  when  A  deliver  gold  to  B  in  New  York,  and  C\ 
in  accordance  with  advices  cabled  by  B,  deliver  gold  in  London 
to  Z)'  for  account  of  A. 

Turning  now  to  the  London  market,  we  may  trace  the  ex- 
changes negotiated  between  Englishmen  as  follows :  A '  payers  of 
London  are  under  obligation  to  deliver  New  York  gold  to  D 
payees  of  New  York,  while  B'  payees  of  London  are  in  receipt  of 
New  York  gold  from  C  payers  of  New  York.  A '  and  B'  contract 
with  each  other  for  the  exchange  of  their  London  gold  and  New 
York  gold  respectively.  In  carrying  out  their  engagements.  A' 
deliver  gold  in  London  to  B\  while  the  latter  cable  C  to  deliver 
the  gold  owing  them  in  New  York  to  D  for  account  of  A\ 

Assume  now  that  the  rates  in  the  two  cities  are  at  disparity, 
so  that  London  gold  is  cheaper  in  London  than  in  New  York,  and 
conversely,  New  York  gold  is  cheaper  in  New  York  than  in  Lon- 
don. Under  these  conditions  some  A  payers  of  New  York,  who 
are  in  a  position  to  avail  themselves  of  the  more  attractive  rate 
in  London,  will  sell  New  York  exchange  in  that  city  to  A'  payers, 
instead  of  buying  London  exchange  in  New  York  from  B  payees. 
The  exchanges  are  consummated  when  A  deliver  gold  in  New 


THE  DUAL  SYSTEM  OF  EXCHANGE  41 

York  to  D  in  behalf  of  A\  and  A'  deliver  gold  in  London  to  D'  ia 
behalf  of  A.  Similarly,  some  of  A'  payers  of  London  will  take 
advantage  of  the  more  favorable  rate  in  New  York  by  selling 
London  exchange  in  that  city  to  A  payers,  in  lieu  of  buying  New 
York  exchange  in  London  from  B'  payees.  The  contracts  are 
executed  when  ^'  deliver  gold  in  London  to  D'  payees  for  account 
of  -4,  and  A  deliver  gold  in  New  York  to  D  payees  for  account  of 
A'.  On  the  other  hand,  B  payees  of  New  York  and  B'  payees  of 
London  find  it  to  their  advantage,  in  view  of  the  existing  position 
of  the  rates,  to  transact  their  exchanges  in  their  home  markets, 
by  selling  respectively  London  and  New  York  exchange. 

In  the  opposite  case  of  disparity  between  the  rates,  when  New 
York  gold  is  dearer  in  New  York  than  in  London,  and,  vice  versa, 
when  London  gold  is  dearer  in  London  than  in  New  York,  some 
B  payees  of  New  York  will  purchase  New  York  exchange  in  Lon- 
don from  B'  payees,  instead  of  selling  London  exchange  in  New 
York  to  A  payers.  They  will  instruct  C  payers  of  London  to 
deliver  for  their  account  gold  in  London  to  B'  payees,  who  in  their 
turn  will  order  C  payers  of  New  York  to  deliver  for  their  account 
gold  in  New  York  to  B  payees.  At  the  same  time  some  B' 
payees  of  London  will  purchase  London  exchange  in  New  York 
from  B  payees,  instead  of  selling  New  York  exchange  in  London 
to  A'  payers.  They  will  order  C  payers  of  New  York  to  deliver 
for  their  account  gold  in  New  York  to  B  payees,  who  on  their  part 
will  direct  C  payers  of  London  to  dehver  in  their  behalf  gold  in 
London  to  B'  payees.  As  for  A  payers  of  New  York  and  A' 
payers  of  London,  it  is  to  their  interest  under  the  prevailing  rate 
situation  to  confine  their  exchanges  to  their  respective  home 
markets,  for  A  to  buy  London  exchange  in  New  York  and  for  A^ 
to  buy  New  York  exchange  in  London. 

The  Tendency  of  the  Spot  Cable  Rates  in  the  Two  Centers  to 
Balance. — In  analyzing  the  constant  tendency  of  the  spot  cable 
rates  in  the  two  centers  to  make  for  mutual  equality,  we  shall 


42  FOREIGN  EXCHANGE 

assume  concrete  cases  of  disparity  and  show  how  in  each  instance 
forces  automatically  come  into  play  to  bring  the  rates  together. 
Let  us  first  take  the  case  where  London  gold  is  cheaper  in  London 
than  in  New  York,  and,  vice  versa,  where  New  York  gold  is  cheaper 
in  New  York  than  in  London.  Suppose  that  when  the  rate  for 
London  spot  cables  in  New  York  is  481  grains  (of  New  York  gold), 
or  expressed  in  full 

481  grains  of  New  York  gold 
480  grains  of  London  gold 

the  rate  for  New  York  spot  cables  in  London  is  479^  grains  (of 
London  gold),  or  the  ratio 

480  grains  of  New  York  gold 
479i  grains  of  London  gold 

To  render  these  ratios  comparable  it  is  obviously  necessary  either 
to  reduce  the  second  to  the  denominator  of  the  first  and  thus  as- 
certain the  amount  of  New  York  gold  which  480  grains  of  London 
gold  is  exchangeable  for  in  London,  or  to  reduce  the  first  ratio  to 
the  numerator  or  upper  term  of  the  second,  and  arrive  at  the 
amount  of  London  gold  that  480  grains  of  New  York  gold  will 
fetch  in  New  York.  Taking  first  the  former  basis  of  comparison, 
inasmuch  as  the  London  ratio  is  equivalent  to 

480! f  f  grains  of  New  York  gold 
480  grains  of  London  gold 

480        48oif| 


i.e., 


479i         480 


it  is  evident  that  while  in  New  York,  480  grains  of  London  gold 
will  bring  481  grains  of  New  York  gold,  in  London  the  same 
amount  of  London  gold  will  bring  only  48o|ff  grains  of  New 
York  gold.     The  two  rates  of  exchange  are  accordingly  unequal, 


THE  DUAL  SYSTEM  OF  EXCHANGE  43 

and  exchangers  of  London  gold  stand  to  obtain  for  480  grains  of 
it,  4y|  of  a  grain  more  of  New  York  gold  by  selling  London  ex- 
change in  New  York  than  by  purchasing  New  York  exchange  in 
London.  In  the  technical  language  of  foreign  exchange  dealers, 
the  480! f  f  grains  of  New  York  gold  which  480  grains  of  London 
gold  will  fetch  in  London  is  the  "parity'^  of  the  prevailing  London 
rate  of  479^^  grains  (of  London  gold).  The  disparity  in  the  rates 
is,  therefore,  one  in  which  the  New  York  rate  is  above  the 
*' parity"  of  the  London  rate. 

Another  Example. — Turning  now  to  the  other  basis  of  com- 
parison, or  the  amount  of  London  gold  which  480  grains  of  New 
York  gold  exchanges  for  in  each  market,  since  the  New  York 
ratio  is  equivalent  to 

480  grains  of  New  York  gold 
479^^x  grains  of  London  gold 

481         480 


i.e., 


480      479t¥t 


480  grains  of  New  York  gold  will  accordingly  exchange  for  479 j^t 
grains  of  London  gold  in  the  New  York  market,  as  against  4793- 
grains  of  London  gold  in  the  London  market.  Hence,  exchangers 
of  New  York  gold  will  receive  for  480  grains  of  it  -|J|  of  a  grain 
more  of  London  gold  if  they  sell  New  York  exchange  in  London 
than  if  they  purchase  London  exchange  in  New  York.  It  will  be 
observed  that  the  current  London  rate  is  above  the  parity  of  the 
New  York  rate,  or  479xiT  grains,  so  that  the  disparity  of  the  two 
rates  is  one  in  which  they  are  each  above  the  parity  of  the  other. 

To  glance  at  the  diagram  again,  with  the  two  rates  in  the  posi- 
tion of  disparity  we  are  assuming,  A  payers  of  New  York,  as  ex- 
changers of  New  York  gold,  will  fare  better  if  they  sell  New  York 
cables  in  London  than  if  they  purchase  London  cables  at  home, 
while  A^  payers  of  London,  as  exchangers  of  London  gold,  will 


44  FOREIGN  EXCHANGE 

obtain  better  results  if  they  sell  London  cables  in  New  York  than 
if  they  buy  New  York  cables  in  London.  But,  in  the  very  nature 
of  the  case,  not  all  of  A  and  A^  can  thus  resort  to  each  others' 
market.  As  a  matter  of  actual  experience,  the  number  of  those 
/who  thus  perform  their  exchanges  abroad  is  restricted  to  a  few 
bankers,  who  have  the  requisite  facilities  for  the  purpose.  The 
general  run  of  A  and  -4'  payers  remain  at  home  and  constitute  the 
source  of  demand  for  exchange  in  their  respective  markets. 

The  Effect  of  Disparity  of  Exchange  Rates. — The  existence 
of  the  disparity  has  also  the  effect  of  inducing  some  in  both  cities 
to  exchange  London  gold  for  New  York  gold  in  New  York,  and 
immediately  to  re-exchange  the  New  York  gold  for  London  gold 
in  London,  as  the  execution  of  such  mutually  offsetting  exchanges 
yields  them  a  profit  amounting  to  the  difference  between  the  rates. 
Thus,  if  they  sell  at  the  same  time  480  grains  of  London  cables  in 
New  York  for  481  grains  of  New  York  gold,  and  480m  grains  of 
New  York  cables  in  London  for  480  grains  of  London  gold,  the 
two  exchanges  completely  balance  each  other  so  far  as  gold  in 
London  is  concerned,  while  in  New  York  there  is  an  excess  re- 
maining amounting  to  4 J|  of  a  grain,  or  the  difference  between 
the  current  rate  of  481  grains  and  the  London  parity  of  48o|-§-J 
grains.  On  the  other  hand,  if  480  grains  of  New  York  cables  are 
sold  in  London  for  479 j  grains  of  London  gold,  and  at  the  same 
time  479^tT  grains  of  London  cables  are  sold  in  New  York  for  480 
grains  of  New  York  gold,  the  two  exchanges  cancel  each  other 
absolutely  as  regards  gold  in  New  York,  while  in  London  a  differ- 
ence is  left  equal  to  the  prevailing  rate  of  479^  grains  less  the 
New  York  parity  of  479^  J  r  grains,  or  |  J  |  of  a  grain.  Operations 
of  this  sort  are  in  reality  a  form  of  arbitraging,  and  we  shall  refer 
to  them  as  such,  although  usage  among  exchange  dealers  limits 
the  term  generally  to  transactions  of  a  similar  nature  conducted 
between  three  or  more  centers,  which  we  shall  discuss  in  Chapter 
VIL 


THE  DUAL  SYSTEM  OF  EXCHANGE  45 

From  the  above  illustrations  it  is  dear  that  when  the  spot 
cable  rates  in  the  two  markets  are  at  disparity,  each  above  the 
parity  of  the  other,  offerings  of  New  York  gold  are  diverted  from 
New  York  to  London,  and  of  London  gold,  from  London  to  New 
York.  In  other  words,  the  demand  for  London  exchange  in  New 
York,  and  for  New  York  exchange  in  London,  decreases,  while  the  ^ 
supply  in  each  case  increases.  As  a  result  of  this  readjustment 
the  rates  in  both  centers  decline,  and  in  so  doing  they  approach 
equality.  When  they  attain  the  parity  relation,  as  they  eventu- 
ally will,  the  volume  of  New  York  gold  offerings  will  bear  the 
same  relation  to  the  volume  of  the  London  gold  offerings  in  both 
cities;  that  is  to  say,  the  relation  of  the  demand  and  supply  of 
London  exchange  in  New  York  will  be  exactly  the  reverse  of 
that  between  the  demand  and  supply  of  New  York  exchange 
in  London. 

Spot  Cable  Rates  in  Two  Centers,  Each  below  Parity  of  Other. 

— The  opposite  case  of  disparity  between  the  spot  cable  rates  in 
the  two  cities  now  claims  our  attention,  that  is,  when  London  gold 
is  dearer  in  London  than  in  New  York,  and,  conversely,  when 
New  York  gold  is  dearer  in  New  York  than  in  London.  A  situ- 
ation of  this  sort  obtains  when  the  quotation  for  London  cables  in 
New  York  is  481  grains  (of  New  York  gold),  or  the  ratio 

481  grains  of  New  York  gold 
480  grains  of  London  gold 

and  the  rate  for  New  York  cables  in  London  is  478^  grains  (of 
London  gold),  or  the  ratio 

480  grains  of  New  York  gold 
478^  grains  of  London  gold 

If  to  compare  these  ratios  we  reduce  the  latter  to  the  denominator 
of  the  New  York  ratio,  making  it 


46  FOREIGN  EXCHANGE 

48 1|^^  grains  of  New  York  gold 
480  grains  of  London  gold 

480  _  48ilfi 
^•^•'                                     478^-         480     ' 

it  becomes  apparent  at  once  that  for  480  grains  of  London  gold 
I  f  g^  of  a  grain  more  of  New  York  gold  can  be  obtained  by  pur- 
chasing New  York  cables  in  London  than  by  selling  London  cables 
in  New  York.  It  will  be  observed  that  in  the  case  of  this  sort  of 
disparity  the  New  York  rate  is  below  the  London  parity,  which 
in  the  example  above  is  481^^1^  grains. 

If  the  comparison  of  the  ratios  is  made  by  reducing  the  New 
York  ratio  to  the  numerator  or  upper  term  of  the  London  ratio, 
making  it 

480  grains  of  New  York  gold 

479^iy  grains  of  London  gold 

481  480 


1.6., 


480      479TiT 


it  immediately  becomes  evident  that  for  480  grains  of  New  York 
gold  |g f  of  a  grain  more  of  London  gold  can  be  procured  if  Lon- 
don cables  are  purchased  in  New  York  than  if  New  York  cables 
are  sold  in  London.  The  London  rate,  it  will  be  noticed,  is  below 
the  New  York  parity  of  479^1  y  grains.  Hence  the  disparity  is 
one  in  which  the  rates  in  both  centers  are  each  below  the  parity  of 
the  other. 

Referring  again  to  the  diagram,  it  is  readily  seen  that  under 
the  assumed  relation  of  the  rates  it  is  more  advantageous  for  B 
payees  of  New  York  to  purchase  New  York  cables  in  London 
than  to  sell  London  cables  in  New  York;  and  for  B'  payees  of 
London  to  purchase  London  cables  in  New  York  than  to  sell  New 
York  cables  in  London.  Here  again,  it  is  only  a  few  bankers  who 
are  ordinarily  in  a  position  to  avail  themselves  of  the  more  ad- 


THE  DUAL  SYSTEM  OP  EXCHANGE  47 

vantageous  rate  in  the  foreign  market.  The  general  rank  and  file 
of  B  and  B'  payees  will  execute  their  trades  in  their  respective 
home  markets  and  furnish  the  supply  of  exchange. 

Under  this  rate  disparity  also  there  is  an  opportunity  for 
profitable  arbitraging  between  the  two  cities,  that  is,  for  the^ 
simultaneous  exchange  of  New  York  gold  for  London  gold  in  New 
York,  and  of  London  gold  for  New  York  gold  in  London.  By 
purchasing  480  grains  of  London  cables  in  New  York  for  481 
grains,  and  48i|f  |  grains  of  New  York  cables  in  London  for  480 
grains,  the  arbitrageur  makes  a  profit  of  -g^f  ^  of  a  grain  of  New 
York  gold,  or  the  difference  between  the  London  parity  of  481^!^ 
grains  and  the  New  York  rate  of  481  grains.  Or  if  he  buys  480 
grains  of  New  York  cables  in  London  for  478^  grains,  and  479jiT 
grains  of  London  cables  in  New  York  for  480  grains,  he  realizes 
f  If  of  a  grain  of  London  gold,  or  the  New  York  parity  of  479^^^^ 
grains  minus  the  London  rate  of  478^  grains. 

Effect  of  Rates  below  Parity. — It  is  clear,  then,  that  when  the 
rates  are  each  below  the  parity  of  the  other,  offerings  of  New  York 
gold  are  attracted  from  London  to  New  York,  and  of  London  gold 
from  New  York  to  London;  that  is  to  say,  the  demand  for  Lon- 
don cables  in  New  York  rises,  while  the  supply  falls  off;  and  con-  ^ 
currently,  the  demand  for  New  York  cables  in  London  increases, 
while  the  supply  diminishes.  The  rates  in  both  centers  therefore, 
advance;  and  as  they  do  so,  they  draw  toward  mutual  parity. 

The  proposition  is,  therefore,  established  that  the  rates  for 
spot  cable  transfers  in  the  two  centers  tend  ever  to  equality  with 
each  other.  Any  departure  from  this  parity  relation  immedi- 
ately sets  into  operation  forces  which  tend  to  even  them  up. 


Further  Observations  on  Parity  Relations. — The  promptness 
with  which  the  spot  cable  rates  tend  to  adjust  themselves  to 
parity  depends  upon  the  size  and  frequency  of  the  exchanges  cur- 
rently transacted  between  the  two  cities.    Where  dealings  are 


^ 


48  FOREIGN  EXCHANGE 

on  a  limited  scale  and  the  markets  narrow,  quoted  prices  do  not 
represent,  except  remotely,  the  rates  at  which  exchange  in  any 
quantity  can  actually  be  bought  or  sold.  The  instability  of  the 
rates  is,  therefore,  hardly  calculated  to  encourage  arbitraging,  or 
to  persuade  A  and  A'  payers,  when  the  rates  are  each  above  the 
parity  of  the  other,  or  B  and  B'  payees,  when  the  rates  are  each 
below  the  parity  of  the  other,  to  perform  exchanges  with  one 
another.  In  those  circumstances,  instead  of  moving  in  close  sym- 
pathy with  each  other,  the  rates  will  act  more  or  less  independ- 
ently, approximating  parity  only  in  a  remote  degree.  But,  as 
between  New  York  and  London,  the  exchange  business  is  con- 
ducted on  such  an  enormous  scale  that  their  markets,  particu- 
larly the  one  in  New  York,  permit  of  any  normal  volume  of 
buying  and  selling  without  undue  fluctuation  of  the  rates,  and 
conditions  are,  therefore,  favorable  for  the  effective  maintenance 
of  the  parity  of  the  quotations. 

Plainly,  the  common  ratio  in  which  New  York  gold  tends  to 
exchange  for  London  gold  in  both  markets  is  determined  solely 
by  the  relation  of  the  volume  of  payments  made  in  the  one  direc- 
tion to  the  total  made  in  the  other  direction.  In  what  proportions 
the  gold  deliveries  are  divided  between  the  two  cities  has  in  real- 
ity no  bearing  on  the  rate,  but  merely  represents  to  what  extent 
exchanges  are  performed  by  Americans  on  the  one  hand,  and  by 
Englishmen  on  the  other.  Most  of  the  payments  are  effected  by 
the  delivery  of  gold  in  London,  as  previously  stated,  with  the 
consequence  that  dealings  in  London  exchange  in  New  York  are 
considerably  greater  than  in  New  York  exchange  in  London. 
But  because  of  arbitraging  and  the  other  exchange  operations 
conducted  between  the  people  of  the  two  cities,  the  relation  of  the 
volume  of  New  York  gold  offerings  to  the  volume  of  London  gold 
offerings  tends  to  be  the  same  in  both  centers,  and  the  rates  make 
for  parity  at  a  point,  above  or  below  the  par  of  480  grains,  which 
is  fixed  by  the  relation  which  the  total  of  New  York  gold  offerings 
in  both  cities  bears  to  the  similar  total  of  London  gold  offerings. 


THE  DUAL  SYSTEM  OP  EXCHANGE  49 

Process  of  Adjustment  to  New  Level. — While  a  change  in 
this  common  rate  merely  reflects  an  altered  relation  of  the  total 
payments  made  in  one  direction  to  the  total  made  in  the  other 
direction,  it  is  seldom  that  the  adjustment  to  the  new  level  takes 
place  without  temporarily  destroying  the  parity  of  the  markets. 
If  the  payments  from  London  to  New  York,  for  example,  are 
suddenly  augmented  and  are  made  entirely  by  the  delivery  of 
gold  in  London,  the  rapid  enlargement  of  the  supply  of  London 
exchange  in  New  York  will  not  be  immediately  counterbalanced 
by  a  proportionate  expansion  of  the  demand  for  New  York  ex- 
change in  London.  Under  those  circumstances  the  rate  in  New 
York  will  undergo  a  sudden  decline,  which  will  not  be  met  at 
once  by  a  corresponding  advance  in  the  rate  in  London.  Dis- 
parity will,  therefore,  appear  between  the  quotations.  But 
within  a  few  hours  the  action  of  arbitrageurs  and  others  {B  and 
B'  in  the  diagram)  who  will  not  be  slow  to  take  advantage  of  the 
situation,  will  begin  to  tell,  and  the  resulting  redistribution  of  the 
gold  offerings  between  the  two  cities  will  again  establish  an  iden- 
tical relation  between  them  in  the  two  markets  and  bring  the 
rates  to  equality.  In  the  process  both  rates  will  be  affected. 
But  the  greatest  change  will  occur  in  the  rate  in  London,  where 
the  market  is  narrower.  That  is  to  say,  parity  will  be  restored 
rather  through  a  fall  in  the  London  rate  than  through  an  advance 
in  the  New  York  rate.  Thus  it  is  seen  that,  while  the  two  mar- 
kets are  interdependent,  London  is  nevertheless  largely  domin- 
ated by  New  York.  The  rate  in  the  latter  place  is  regulated 
mainly  by  the  ordinary  demand  and  supply,  whereas  the  rate 
in  London  usually  follows  it  in  sympathy,  in  answer  to  the 
conditions  of  demand  and  supply  resulting  from  the  activities 
of  arbitrageurs. 

Concurrent  Specie  Points  in  the  Two  Centers. — When  the 
intercity  payments  are  running  on  balance  in  favor  of  London,  a 
given  quantity  of  London  gold  commands  in  both  places  a  greater 

4 


50  FOREIGN  EXCHANGE 

amount  of  New  York  gold;  and  London  cables  in  New  York  are 
accordingly  at  a  premium,  while  New  York  cables  in  London  are 
at  a  discount.  As  this  excess  of  payments  grows  larger,  the  pre- 
mium and  the  discount  increase;  and  with  the  continuance  of  the 
tendency,  the  rates  eventually  reach  their  respective  gold  points 
— the  export  point  in  New  York  and  the  import  point  in  London 
— at  the  same  time,  provided  they  maintain  mutual  parity.^ 
If  the  rates  move  beyond  these  specie  points,  gold  consignments 
can  be  undertaken  with  equal  advantage  by  shippers  of  both 
cities,  if  they  incur  the  same  expense  and  interest  loss  (at  the 
London  rate)  on  the  shipments.  In  arbitraging  against  their 
shipments  they  will  naturally  perform  their  offsetting  exchanges 
in  the  more  favorable  market  if  the  rates  happen  to  be  at  dis- 
parity. 

When  the  balance  of  settlements  in  favor  of  London  declines, 
the  rates  draw  together  toward  the  par  of  480  grains,  which  is 
reached  when  the  payments  in  the  one  and  the  other  direction 
exactly  offset  each  other.  Thereafter,  if  the  current  of  payments 
to  New  York  overbalances  the  current  to  London,  the  rates  again 
draw  away  from  par;  but  this  time  London  cables  in  New  York 
decline  to  a  discount,  while  New  York  cables  in  London  advance 
to  a  premium,  since  now  a  given  amount  of  New  York  gold  ex- 
changes for  a  greater  quantity  of  London  gold  in  both  centers. 
Ultimately,  if  the  balance  of  payments  in  favor  of  New  York 
continues  to  grow,  the  rate  in  New  York  will  arrive  at  the  gold 
import  point,  and  the  rate  in  London  will  simultaneously  touch 
the  gold  export  point,  if  the  parity  relation  is  preserved  between 

» As  the  gold  export  rate  in  New  York  is  equal  to  (480  -|-  e)  (i  -j-  /)  (see 
page  27),  the  parity  rate  in  London  is — 


1^. 


(480 +  e)  (I  +1) 
(480  +  e)  (1+  I)  480 


480  480' 


(4804-^)  (I  +/) 
which  is  the  London  gold  import  rate. 


THE  DUAL  SYSTEM  OP  EXCHANGE  5I 

them.  3  When  the  rates  exceed  their  specie  points,  consigners  in 
both  cities  can  forward  the  metal  from  London  to  New  York  on 
an  equal  footing  if  they  incur  the  same  expense  and  interest  loss 
(at  the  New  York  rate). 

Efifect  of  Different  Quotation  Methods  in  Two  Cities. — 

Throughout  this  analysis  of  the  dual  system  of  transacting  gold 
exchanges  between  the  two  cities  through  the  medium  of  the  spot 
cable  transfer,  we  assumed  the  use  of  the  first  method  of  quota- 
tion in  both  centers,  having  expressed  the  rate  in  New  York  in 
terms  of  New  York  gold,  and  the  rate  in  London  in  terms  of  Lon- 
don gold.  But  as  has  already  been  stated,  while  New  York 
quotes  its  rate  according  to  this  system,  London  in  actual  prac- 
tice employs  the  other  system,  denoting  the  rate  for  New  York 
exchange  in  New  York  gold.  Quotations  in  both  centers  ac- 
cordingly refer  to  the  amount  of  New  York  gold  which  is  ex- 
changeable for  480  grains  of  London  gold.  It  follows,  then,  that 
when  the  rates  are  in  parity,  they  are  indicated  by  an  identical 
figure.  Thus,  if  the  rate  in  New  York  is  48 1  grains,  its  equivalent 
in  London  is  also  481  grains,  both  having  reference  to  the  ratio 

481  grains  of  New  York  gold 
480  grains  of  London  gold 

The  employment  of  different  methods  of  quotation  in  the  two 
cities  has  the  obvious  advantage  of  rendering  a  comparison  of .7 
their  rates  easier.     Moreover,  under  these  varying  systems  of 
indicating  rates,  the  gold  export  rate  in  New  York  and  the  gold 

3  As  the  gold  import  rate  in  New  York  is  7-r — r~Fn — r^x  (see  page  29), 

(480  +  £)  (i  + 1)         ^  ^      ^' 

the  equivalent  rate  in  London  is  (480  +  £)  (i  +  *), 

480 » 
i^g^  U8o  +  £)  (I  +0  480 


480  (480  +  £)  (i  -H  ») 

which  is  the  London  gold  export  rate. 


52  FOREIGN  EXCHANGE 

import  rate  in  London  are  both  equal  to  (480  -\-  e)  (i  +  /)  (see 
pages  27  and  32),  while  the  gold  import  rate  in  New  York  and 
the  gold  export  rate  in  London  are  both  equal  to 

480^ 


(480  +  £)(!  +  i) 
(see  pages  29  and  ss)- 


CHAPTER  IV 

FUTURE  CABLE  EXCHANGE 

Future  Cable  Exchange  Defined. — Thus  far  only  one  species 
of  exchange,  the  spot  cable  transfer,  less  frequently  called 
"prompt "  or  ''ready  cables,"  has  been  discussed.  In  this  system 
of  exchange  the  two  gold  deliveries  are  made  immediately,  or  as 
soon  as  possible  after  the  bargain  is  closed.  But,  manifestly, 
it  is  also  possible  to  enter  into  engagements  in  the  present  for 
the  exchange  of  gold  at  a  specified  future  time.  Contracts 
which  call  for  such  forward  deliveries  are  commonly  known  by 
the  general  names  of  "future  contracts,"  "future  exchange," 
or  simply  "futures."  As  we  shall  learn  in  the  course  of  our 
discussion  in  this  and  the  next  few  chapters,  there  are  several 
classes  of  future  exchange,  differentiated  from  one  another  in 
respect  to  the  relative  time  stipulated  for  the  two  deliveries. 
Contracts  which  provide  for  deliveries  on  the  same  future  date 
are  referred  to  as  "future  cable  exchange"  or  "future  cables." 
As  they  resemble  spot  cables  in  that  the  two  deliveries  are 
simultaneous,  it  is  logical  to  deal  with  them  next. 

Typical  Future  Exchange  Transaction. — Let  us  commence 
by  examining  the  origin  of  the  supply  and  demand  of  future 
exchange  in  general,  using  future  cables  as  an  illustration.  A 
practical  example  will  serve  our  purpose  best.  A  typical  case 
is  that  of  the  American  grain  exporter,  who  customarily  contracts 
for  the  sale  of  his  stock-in-trade  in  advance,  generally  in  the 
early  spring,  before  the  grain  has  even  been  harvested.  Suppose 
Erskine,  an  exporter  in  New  York,  sells  Arthur,  an  importer 
in  London,  a  quantity  of  wheat  for  i,ooo  ounces  of  gold  payable 
in  London,  on  the  condition  that  the  wheat  be  consigned  and 

53 


J 


54  FOREIGN  EXCHANGE 

the  gold  delivered  3  months  hence.  Let  us  say  that  Erskine 
is  loath  to  take  any  speculative  risks.  Accordingly,  as  soon  as 
he  has  closed  his  sale  contract,  he  enters  at  once  into  another 
for  the  purchase  of  wheat,  likewise  for  delivery  3  months  hence. 
He  thus  protects  himself  against  a  possible  advance  in  the  price 
of  the  commodity  pending  delivery  on  his  sale.  Moreover,  as 
he  intends  to  convert  the  London  gold  he  will  receive  into  gold 
in  New  York,  he  also  proceeds  to  safeguard  himself  against  loss 
from  a  possible  decline  in  the  exchange  rate  in  the  meantime. 
This  he  does  by  contracting  to  exchange  at  a  stipulated  rate 
the  prospective  London  gold  for  New  York  gold  on  the  basis  of 
the  simultaneous  delivery  of  both  lots  at  the  end  of  three  months. 
In  the  technical  phraseology  of  exchange  dealers,  he  sells  a  future 
cable  on  London  for  1,000  ounces.  As  a  matter  of  fact,  he 
makes  certain  of  the  price  he  will  have  to  pay  for  the  wheat  and 
the  rate  he  can  get  for  his  future  cable,  before  he  accepts  Arthur's 
offer  to  purchase;  and  on  the  basis  of  these  two  quotations  he 
computes  the  price  he  must  charge  Arthur  for  the  wheat  to  make 
a  profit  on  the  turnover.  Suppose  he  purchases  the  wheat  for 
900  ounces  of  New  York  gold,  and  sells  the  future  cable  for 
481!^  grains,  which  quotation  refers  to  the  amount  of  New 
York  gold  that  480  grains  of  London  gold  will  yield  in  exchange 
3  months  hence.  When  the  delivery  date  arrives,  he  turns  over 
to  the  buyer  of  the  future  cable  the  1,000  ounces  he  is  paid  in 
London  by  Arthur,  and  receives  from  him  1,003!^  ounces  (1,000  X 
481^  grains)  in  New  York.  He  thus  reaps  a  profit  of  2>\  ounces. 
Here  it  is  natural  to  ask:  Who  was  the  buyer  of  the  cable  and 
why  did  he  make  the  purchase?  We  may  answer  the  question 
by  supposing  that  at  the  time  Erskine  was  arranging  his  sale 
of  wheat,  Dalton,  an  importing  jnerchant  in  New  York,  was 
purchasing  a  bill  of  goods  from  Carter  of  London  for  1,000 
ounces  payable  in  London  at  the  end  of  3  months;  and  that  he 
likewise  did  not  care  to  incur  the  risk  of  loss  from  an  adverse 
movement,  that  is,  from  an  advance  in  the  spot  cable  rate  in 


i 


FUTURE  CABLE  EXCHANGE  5§ 

the  meantime.  He,  therefore,  took  the  precaution  of  purchasing 
a  future  cable.  Now  that  the  contract  has  matured,  he  dehvers 
the  1,003^  ounces  of  New  York  gold  to  Erskine,  who  on  his  part 
cables  his  customer,  Arthur,  in  London  to  pay  the  1,000  ounces 
owing  him  to  Carter  for  account  of  Dalton.  Thus  by  agree- 
ing in  advance  on  the  rate  at  which  they  should  mutually  ex- 
change London  gold  for  New  York  gold  3  months  later,  Erskine 
and  Dalton  relieved  each  other  from  the  necessity  of  assuming 
any  speculative  commitment  on  the  future  course  of  the  spot 
rate. 

Sources  of  Future  Exchange. — The  grain  exporter  in  the  ^ 
above  example  typifies  the  principal  source  of  supply  of  future 
exchange,  which  takes  in  all  who  on  one  account  or  another, 
either  because  of  their  present  or  past  sales  of  merchandise  and 
securities  on  the  other  side,  or  the  approaching  maturity  of  their 
British  investments,  will  come  into  possession  of  London  gold, 
and  prefer  to  fix  in  the  present  the  rate  at  which  they  will 
convert  it  into  New  York  gold.  The  main  source  of  demand 
for  future  exchange  is  exemplified  by  Dalton,  the  New  York  . 
importer.  It  comprises  all  who,  like  him,  are  entering,  or  have  ' 
already  entered  into  engagements  to  deliver  gold  in  London  at 
a  certain  future  time,  either  on  account  of  present  or  past  pur- 
chases made  abroad,  or  on  account  of  borrowings  shortly  to 
mature  in  London,  and  at  the  same  time  desire  to  settle  without 
further  delay  the  question  of  the  rate  at  which  they  shall  exchange 
New  York  for  London  gold  when  they  must  make  payment. 

The  other  general  source  of  demand  and  supply  of  future 
exchange  consists  of  the  speculative  element  among  foreign 
exchange  traders.  Their  output  or  absorption  of  this  class  of 
exchange  runs  into  fairly  large  totals  at  certain  seasons  of  the 
year.  When  they  anticipate  a  decline  in  the  spot  rate,  say, 
in  the  next  2  months,  they  sell  futures  (sell  them  ''short,"  in 
the  parlance  of  speculators)  to  run  for  approximately  that  period; 


5^  l^ORElGN  EXCHANGE 

and  subsequently,  with  the  approach  of  the  delivery  day,  they 
purchase  spot  cables  by  way  of  securing  London  gold  to  protect 
their  future  contracts.  They  are  successful  or  fail  in  their 
speculations,  depending  upon  whether  they  pay  a  lower  or  a 
higher  price  for  the  spot  exchange  than  that  at  which  they 
have  sold  their  futures.  In  the  other  case,  when  they  look  for  an 
advance  in  the  spot  rate  in  the  next  few  weeks  or  months,  they 
purchase  future  cables;  and  later,  upon  the  maturity  of  the 
contracts,  they  sell  spot  exchange  against  their  receipt  of  London 
gold,  making  a  profit  or  suffering  a  loss  according  as  they  obtain 
a  higher  or  a  lower  rate  than  they  have  paid  for  the  future. 

Delivery  Dates. — Future  exchange  is  bought  and  sold  for 
various  maturities,  ranging  usually  from  several  days  to  several 
months.  The  actual  time  of  delivery  may  be  the  last  day,  week, 
fortnight,  or  month  the  contracts  run,  depending  largely  upon 
whether  their  term  is  short  or  long.  Where  the  delivery  period 
is  longer  than  a  day,  the  contracts  stipulate  whether  the  seller 
has  the  option  of  tendering,  or  the  buyer  of  demanding  delivery 
of  London  gold  on  any  day  he  elects  within  the  designated  time. 
As  between  exchange  dealers,  future  contracts  usually  provide 
for  seller's  option.  Where  the  buyer  is  accorded  the  privilege 
J  of  naming  the  exact  delivery  date,  he  is  charged  a  slightly  higher 
rate  than  for  contracts  of  the  same  maturity  granting  the  right 
to  the  seller. 

Spot  and  Future  Cable  Rates  at  Mutual  Parity. — After  this 
brief  description  of  the  nature  of  future  exchange  and  the  general 
purpose  it  serves,  the  relation  which  the  spot  and  future  cable 
rates  tend  to  maintain  to  each  other  comes  up  for  discussion. 
The  two  types  of  exchange  make  for  a  state  of  mutual  equivalence, 
\i  if  the  factor  of  interest  for  the  period  of  the  future  is  taken  into 
account.  In  proving  this  tendency,  the  best  procedure  is  first 
to  ascertain  the  relationship  of  the  rates  when  they  are  thus 


FUTURE  CABLE  EXCHANGE  57 

at  parity,  and  then  demonstrate  that  they  tend  to  keep  that 
relationship. 

A  person  in  New  York  who  has  a  debt  to  pay  in  London  on 
a  certain  future  date,  can  avoid  the  risk  of  a  subsequent  advance 
in  the  spot  rate  either  by  buying  a  spot  cable  in  the  present  and 
lending  out  the  London  gold  he  gets  thereby  until  the  maturity 
of  his  debt;  or  by  buying  a  future  cable  for  dehvery  on  the  due 
date  of  his  obligation,  and  in  the  meantime  lending  out  his  gold 
in  New  York.  In  deciding  between  these  two  forms  of  remit- 
tance he  will  naturally  be  governed  by  the  question  of  their 
relative  cheapness.  He  will  purchase  the  one  which  will  take 
the  smaller  amount  of  present  or  spot  gold  in  New  York  to  yield 
him  on  the  due  date  of  his  debt  the  required  quantity  of  London 
gold.  In  other  words,  he  will  select  the  mode  of  remittance  by 
which  he  will,  actually  or  in  effect,  have  to  part  with  the  smaller 
amount  of  New  York  gold  in  the  present  to  secure  the  necessary 
amount  of  London  gold  when  his  debt  matures.  It  will  be 
observed  that  he  makes  the  comparison  on  the  basis  of  what  to 
all  intents  and  purposes  is  an  exchange  of  New  York  gold  de- 
livered now  for  London  gold  delivered  in  the  future. 

Relation  of  Spot  and  Future  Rates  Illustrated. — Take  the 
instance  of  a  person  in  New  York  who  has  a  debt  to  pay  in  Lon- 
don lo  days  hence,  and  at  the  same  time  desires  to  contract  for 
the  exchange  of  gold  immediately,  in  order  to  escape  the  risk  of  an 
unfavorable  movement  in  the  spot  cable  rate  pending  the  matu- 
rity of  his  obligation.  Assume  that  this  day  is  July  i  and  the 
maturity  day  of  his  debt  is  July  lo.  Suppose  the  spot  cable 
rate  at  the  moment  is  481  grains,  and  the  annual  interest  rate  is 
6%  in  New  York  and  4%  in  London,  or  ^J-^j-  and  -^ 
respectively  for  the  10  days.  If  the  debtor  purchases  a  spot 
cable  and  forthwith  lends  out  the  London  gold  for  10  days,  it 
is  obvious  that  for  every  481  grains  of  New  York  gold  he  delivers 
now,  he  will  have  (|{j^  X  480)  grains  of  London  gold  on  July  10 


58  FOREIGN  EXCHANGE 

to  apply  to  the  liquidation  of  his  obligation.  But  if  instead 
he  should  purchase  a  lo-day  future  and  lend  out  his  New  York 
gold  until  July  lo,  he  will  have  (m  X  481)  grains  to  deliver 
on  the  contract  for  every  481  grains  he  has  loaned.  Assume, 
now,  that  the  rate  he  pays  for  the  future  is  exactly  (IJ-J  X  481) 
grains  of  New  York  gold  against  (|-§^  X  480)  grains  of  London 
gold,  both  delivered  10  days  hence.  In  that  event  the  future 
cable  is  equivalent  to  the  spot  cable,  since  in  purchasing  either 
the  remitter  will  have  (f|-J-  of  480)  grains  of  London  gold  on 
July  10  for  every  481  grains  of  New  York  gold  he  actually  or 
in  effect  gives  up  in  the  present.     But  as  this  future  ratio  of 

(fw  X  481)  grains  of  New  York  gold 
(iw  X  480)  grains  of  London  gold 

is  equal  to  the  "atio 

(lU  X  -Uf  X  481)  grains  of  New  York  gold 
480  grains  of  London  gold 

it  is  evident  that  as  ordinarily  quoted  the  rate  for  the  lo-day 
future  cable  equivalent  to,  or  at  parity  with,  the  spot  cable  rate 
of  481  grains  is  (|§^  X  i^r  X  481)  grains,  which  is  to  say,  that 
the  future  parity  of  the  prevailing  spot  cable  rate  is  equal  to 
the  sum  of  that  spot  rate  and  interest  thereon  at  the  New  York 
rate  for  the  10  days  the  future  cable  runs,  discounted  at  the 
London  rate  of  interest  for  the  same  lo-day  period. 

Assuming  again  the  exchange  quotations  and  interest  rates 
of  the  preceding  example,  let  us  take  the  reverse  case,  where  a 
person  in  New  York  has  in  prospect  the  receipt  of  a  certain 
amount  of  London  gold  on  July  10,  and  wishes  to  enter  now,  that 
is  on  July  i,  into  a  contract  for  the  conversion  of  the  metal  into 
New  York  gold.  He  can  accomplish  his  purpose  either  by  bor- 
rowing in  London  in  anticipation  of  the  receipt  of  the  payment 
and  selling  spot  cables  against  the  proceeds  of  the  loan;  or  by 


FUTURE  CABLE  EXCHANGE  59 

selling  a  future  cable  deliverable  on  July  lo.  Suppose  he  resorts 
to  the  sale  of  spot  cables,  borrowing  (|  J  ?  X  480)  grains  in  London 
for  every  480  grains  he  will  be  paid  on  July  10,  or  an  amount 
which  with  the  10  days'  interest  added  will  just  be  covered  by  the 
payment  he  will  receive.  The  (|  [J-f-  X  480)  grains  of  exchange  he 
sells  bring  him  immediately  (f^?^  X  481)  grains  of  New  York 
gold,  which  loaned  out  to  July  10  will  increase  to  (|^  X  |^ 
X  481)  grains.  He  will,  therefore,  have  this  amount  of  New 
York  gold  on  July  10  for  every  480  grains  he  will  in  effect  de- 
liver on  the  same  date  in  London.  But,  manifestly,  he  would 
fare  exactly  as  well  if  he  sold  a  lo-day  future  cable  at  the  rate  of 
(Iw  X  llf  X  481)  grains.  It  is  thus  apparent  that  in  the  case 
of  either  purchase  or  sale  of  exchange,  the  future  parity  of  the 
spot  cable  rate  of  481  grains  is  (f^  X  Ifr  X  481)  grains. 

Calculating  Spot  and  Future  Cable  Rates. — In  general,  then, 
the  future  cable  parity  of  the  current  spot  cable  price  is  equal  / 
to  the  sum  of  the  spot  price  and  interest  thereon  at  the  New  York  ^ 
rate  for  the  maturity  of  the  future,  discounted  at  the  London 
rate  of  interest  for  the  same  period.  If  we  take  c  to  denote  the 
spot  cable  price,  /  the  future  cable  price,  i  the  interest  rate  in 
New  York,  and  /  the  interest  rate  in- London  for  the  term  of 
the  future,  we  have  the  following  equation: 

c(i  +  i) 
from  which  we  derive  the  converse  equation, 

/(I  +  /) 


c  = 


(x+i) 


Expressed  in  words,  this  latter  equation  reads  as  follows:  The 
spot  cable  parity  of  the  future  cable  price  is  equal  to  the  sum  of 
the  future  price  and  interest  thereon  at  the  London  rate  for  the 


\ 


60  FOREIGN  EXCHANGE 

period  of  the  future,  discounted  for  the  same  space  of  time  at 
the  New  York  interest  rate.  It  will  be  noted  that  when  the 
two  forms  of  exchange  are  at  parity,  the  futB^e  price  is  above  or 
below  the  spot  price  according  as  the  interest  ratfe  is  higher  or 
lower  in  New  York  than  in  London,  and  tEat  the  l^p  prices  are 
identical  quotations  when  the  interest  rates  are  equal. 

In  comparing  the  two  forms  of  remittance  different  methods 
were  used  in  the  two  preceding  examples.  In  the  first  the 
comparison  was  made  on  the  basis  of  the  present  or  spot  delivery 
of  New  York  gold  against  the  future  delivery  of  London  gold, 
while  in  the  second  it  was  made  on  the  basis  of  the  simultaneous 
deHvery  in  the  future  of  the  two  lots  of  gold.  The  change  in 
the  mode  of  comparison  was  made  for  no  other  reason  than  mere 
convenience.  As  a  matter  of  fact,  any  method  may  be  followed 
in  ascertaining  the  relative  cheapness  of  two  different  t)^es  of 
exchange,  provided  it  is  assumed  that  the  New  York  deliveries 
on  the  one  hand,  and  the  London  deliveries  on  the  other,  are 
effected  simultaneously,  and  the  proper  interest  adjustments 
are  made  in  each  center.  It  is  possible,  for  example,  to  make 
the  comparison  of  spot  and  future  cables  on  the  assumption  of 
the  immediate  delivery  of  New  York  and  London  gold  in  the 
case  of  both  forms  of  exchange. 

Tendency  Toward  Mutual  Parity. — That  spot  and  future 
cables  constantly  tend,  with  greater  or  less  force,  to  mutual 
parity,  is  not  difficult  of  demonstration  if  concrete  examples  of 
disparity  are  taken,  and  if  it  is  observed  how  in  consequence 
of  the  disparity  the  demand  and  supply  of  each  class  of  exchange 
undergo  a  process  of  readjustment  which  gradually  restores  the 
rates  to  a  parity  basis.  Assume  that  the  rate  for  spot  cables  is 
481  grains  and  for  lo-day  future  cables  481!^  grains,  and  the 
interest  rate  for  the  10  days  is  -^^  in  New  York  and  -^^  in 
London.  As  the  future  parity  of  the  spot  rate  is  (|f  ^  X  114  X 
481)  grains,  it  is  less  than  the  current  future  rate  by  f^  of  a 


FUTURE  CABLE  EXCHANGE  6l 

grain;  and,  vice  versa,  as  the  spot  parity  of  the  future  rate  is 
(ISi  X  l^f  X  4812^)  grains,  it  is  greater  than  the  actual  spot 
rate  by  H^  of  a  grain.  Spot  cables  are,  therefore,  cheaper  than 
future  cables,  and  will  be  purchased  in  preference  to  the  latter 
by  the  more  alert  remitters  who  have  obligations  to  meet  10  days 
hence  in  London  and  want  to  arrange  their  exchanges  immediately. 
On  the  other  hand,  future  instead  of  spot  cables  will  be  marketed 
by  the  more  enterprising  among  those^hS  are  going  to  acquire 
gold  in  London  in  10  days  and  wish  to  contract  their  exchanges 
in  the  present. 

In  consequence,  then,  of  the  existing  disparity,  the  demand 
for  exchange  will  shift  from  the  future  to  tKf  spot  variety,  while 
the  supply  will  come  upon  the  niarket  more  in  the^hape  of  future 
cables  and  less  in  the  sliape  of  spot  cables  than  previous  to  the 
occurrence  of  the  disparity.  The  spot  price  will,  accordingly, 
advance  and  the  future  price  decline  until  they  arrive  at  a  position 
of  mutual  parity.  These  tendencies  in  the  rates  are  supple- 
mented by  the  activfties  of  those  who  are  in  reali  '  arbitrageurs, 
though  they  are  not  customarily  so  regarded.  orrowing  and 
purchasing  sp6t  cables  in  New  York,  these  opert||ors  lend  the 
London  gold  out  for  10  days,  anji  at  the"  same  time  sell  lo-day 
future  cables  for  an  amount  equal  to  the  Ldhdon  loan,  plus 
interest  thereon.  They  thus  create  an  additional  demand  for 
spot  cables  and  augment  the  supply  of  future  cables.*  X|ieir 
profit  at  the  end  of  the  10  days  will  amount  to  the  difference' 
between  the  prevailing  future  rate  and  the  future  parity  of  the  ; 
spot  rate  on  every  480  grains  of  spot  cables  they  purchase. 

If  we  turn  to  the  opposite  case  of  disparity,  in  which  spot 
cables  are  dearer  than  future  cables,  we  shall  notice  a  similar 
tendency  to  parity  in  the  rates.  An  instance  of  this  sort  of  in- 
equivalence is  afforded  by  taking  the  conditions  of  the  preceding 
example,  except  the  rate  for  futures,  which  we  shall  assume  to 
be  480I  grains.  In  this  situation  the  future  rate  is  below  the 
future  parity  of  (§§^  X  |^f  X  481)  grains,  while  the  spot,  cable 


62  FOREIGN  EXCHANGE 

rate  of  481  grains  is  above  the  spot  parity  of  (|^^  X  f  ^f  X  480}) 
grains.  It  will  now  advantage  those  remitters  who  have  debts 
to  pay  in  London  10  days  hence  to  purchase  future  instead  of 
spot  cables,  while  it  will  be  to  the  interest  of  those  contemplating 
the  present  sale  of  exchange  against  the  receipt  of  London  gold  10 
days  from  now  to  market  spot  instead  of  future  cables. 

The  outcome  of  such  a  rate  situation  is  manifestly  a  lessened 
demand  and  an  augmented  supply  of  spot  cables,  and  an  increased 
demand  and  a  reduced  supply  of  future  cables.  The  rates  will 
respond  accordingly,  the  spot  quotation  falling  and  the  future 
quotation  rising;  as  they  thus  move  away  from  each  other,  they 
will  approach  a  position  of  parity.  The  tendency  is  strength- 
xened  by  the  arbitraging  operations  induced  by  the  disparity  of 
the  rates.  Selling  spot  cables  against  lo-day  loans  they  procure 
in  London,  the  arbitrageurs  lend  the  New  York  gold  out  for  an 
equal  period,  and  at  the  same  time  purchase  lo-day  futures  as 
cover  for  their  borrowings  in  London,  delivery  on  which  they 
will  make  out  of  the  proceeds  they  will  receive  from  the  repay- 
ment of  their  advances.  Their  profit  at  the  end  of  the  10  days 
will  amount  to  a  quantity  of  New  York  gold  equal  to  the  differ- 
ence between  the  future  parity  of  the  current  spot  rate  and  the 
actual  future  rate  on  every  480  grains  of  spot  cables  they  sell. 

Means  of  Parity  Readjustment. — In  either  case  of  disparity 
the  two  rates  are  drawn  to  a  parity  relationship  by  influences 
which  are  automatic  in  their  action.  In  practice,  however,  the 
.readjustment  is  brought  about  through  a  movement  in  the  future 
rather  than  the  spot  quotation.  This  is  because  the  future 
market,  being  far  less  active  than  the  spot  market,  is  more  sen- 
sitive to  the  action  of  the  forces  making  for  parity.  In  the  last 
illustration,  for  example,  the  equivalence  between  the  two  forms 
of  exchange  is  re-established  to  a  greater  extent  by  the  advance 
of  the  future  rate  than  by  the  decline  of  the  spot  rate. 

In  arriving  at  the  law  governing  the  relationship  of  the  two 


FUTURE  CABLE  EXCHANGE  63 

rates,  we  tacitly  assumed  that  trading  in  future  cables  was  of 
sufficient  proportions  actually  to  produce  the  tendency  to  parity. 
With  the  exception  of  a  few  maturities,  however,  which  from  time 
to  time  become  fairly  active  in  answer  to  periodical  or  special 
developments,  business  in  futures  is  too  light  in  volume  to  pro- 
duce any  strong  tendency  to  parity  with  spot  cables,  so  that 
the  relationship  between  the  two  rates  is  usually  a  loose  one. 

Gold  Export  Point  of  Future  Cables. — Where  the  rate  for 
future  cable  exchange  of  a  particular  maturity  actually  tends 
to  keep  the  parity  relation  with  the  rate  for  spot  cables,  its 
fluctuations  approximately  parallel  the  movements  of  the  spot 
quotation.  It  advances  to  a  premium  and  falls  to  a  discount 
below  the  par  of  480  grains  together  with  the  spot  rate,  shifting 
in  the  meantime  its  position  a  trifle  with  reference  to  the  spot 
rate  as  the  interest  rates  in  the  two  centers  change  in  relation 
to  each  other.  But  since  the  movements  of  the  spot  rate  are 
confined  within  limits  above  and  below  par  which  are  fixed  by 
the  cost  and  interest  loss  on  gold  shipments  to  London,  the 
fluctuations  of  the  future  rate  must  needs  be  also  restricted  within 
a  well-defined  area  above  and  below  par.  The  limits  of  this 
area  are  the  points  at  which  future  cables  are  equivalent  to  gold 
consignments. 

Let  us  first  consider  the  gold  export  point  of  a  future  cable 
running  for  the  time  required  to  ship  gold  to  London,  which  we 
shall  assume  to  be  10  days.  Suppose  the  total  cost  of  carriage 
is  12^  grains  per  480  grains,  and  the  lo-day  interest  rate  is  ^^0 
in  New  York  and  -^^q  in  London.  Under  these  conditions  the 
gold  export  rate  for  spot  cables  is  (f  |i  X  481^)  grains  (see  page 
26),  while  the  future  parity  of  the  spot  rate  is  [|J^  X  IS?  X 
iUl  X  481^)],  or  (Ui  X  481I)  grains  (see  page  59).  That  this 
latter  quotation  is  the  existing  gold  export  rate  for  the  lo-day 
future  cables  requires  for  proof  only  the  citation  of  an  example. 
Suppose  a  remitter  purchases  a  future  at  this  rate.    For  every 


64  FOREIGN  EXCHANGE 

48 1 1-  grains  he  has  at  present,  he  can  purchase  480  grains  of  the 
future,  since  481 J  grains  put  out  at  interest  in  New  York  for  the 
life  of  the  future  will  increase  to  (|^^  X  481^)  grains.  But  he 
would  do  precisely  as  well  if  he  shipped  gold  instead,  since  he 
would  likewise  have  480  grains  in  London  ten  days  hence  against 
every  481 J  grains  he  has  now  in  New  York.  The  purchase  of 
the  future  cable  being  thus  equivalent  to  the  export  of  gold^ 
(fU  X  48 1^)  grains  is  the  future  cable  gold  export  point. 

The  Future  Export  Rate. — Spot  cables  and  future  cables 
deliverable  in  the  time  necessary  to  complete  a  gold  shipment 
tend  thus  to  arrive  together  at  their  respective  export  points,  and 
the  future  export  rate  is  equal  to  the  sum  of  the  par  of  480 
grains  and  the  expense  incident  to  the  shipping  of  that  amount 
of  gold  to  London,  plus  interest  on  this  sum  at  the  New  York 
rate  for  the  shipping  period  or  the  life  of  the  future.  Stated 
algebraically,  the  future  export  rate  equals  (480  +  e)  (i  +  i). 
The  spot  and  future  cable  export  points,  then,  differ  only  in  this, 
\  that  in  the  case  of  the  spot  export  point  the  interest  loss  on  the 
V^old  consignment  is  calculated  at  the  London  rate,  while  in  the 
case  of  the  future  export  point  it  is  figured  at  the  New  York  rate. 

Gold  Import  Point  of  Future  Cable  Exchange. — Next  to  be 
discussed  is  the  gold  import  point  of  future  cable  exchange  matur- 
ing in  the  time  required  to  bring  gold  over  from  London,  which 
we  shall  assume  to  be  10  days.  Suppose  the  lo-day  interest 
rates  in  the  two  cities  are  the  same  as  in  the  preceding  example, 
and  the  cost  of  importing  480  grains  from  London  is  i^  grains. 

rj..  .  .    .      ,  /600  X  480  ^         .       , 

The  spot  import  rate  is  m  that  case  (7 — rz — ^ )  grains  (see 

page  29),  while  the  future  parity  of  this  rate  is 

/.  600  X  480  ^        /900  X  480  *\ 


FUTURE  CABLE  EXCHANGE  65 

which  is  also  the  gold  import  point  of  the  future,  as  the  follow- 
ing example  will  show.  If  a  person  in  New  York  undertakes  to 
ship  home  the  gold  he  owns  in  London,  the  consignment  will 
net  him  480  grains  in  New  York  10  days  hence  for  every  48 in- 
grains he  has  now  in  London,  the  difference  of  i|^  grains  being 
absorbed  by  the  transportation  charges.  Suppose,  however,  he 
decides  upon  the  sale  of  a  lo-day  future'  at  the  above  mentioned 
rate.  Pending  his  delivery  of  London  gold  on  the  contract, 
every  481!^  grains  will  be  increased  by  interest  to  {^^  X  481  j) 
grains.  He  can  accordingly  sell  a  future  for  that  amount,  on 
which  he  will  receive  at  the  end  of  10  days  480  grains  in  New  York, 

900  X  480  ^ 


901  X  481 2-  480 

I.e., 


480  901  X  481!^ 

900 

Thus,  whether  he  imports  the  metal  or  sells  a  lo-day  future 
against  it,  he  will  be  in  possession  of  480  grains  in  New  York 
10  days  from  now,  for  every  481!^  grains  he  has  at  present  in 
London.    Hence 

900  X  480^ 

901  X  481 2- 

is  the  gold  import  rate  for  the  lo-day  future. 

We  may,  therefore,  conclude  that  the  spot  and  future  cable 
rates  tend  to  touch  their  respective  import  points  simultaneously, 
and  that  the  future  import  rate  is  equal  to  the  square  of  the  par 
of  480  grains  divided  by  the  following  quantity:  the  sum  of  par 
and  the  cost  of  importing  the  par  amount  of  gold,  plus  interest 
on  this  sum  at  the  London  rate  for  the  transportation  period  or 
the  life  of  the  future.  Expressed  in  algebraic  terms,  the  future 
import  point  equals 

480^ 

(480 +£)  (i  +/)' 


66  FOREIGN  EXCHANGE 

From  this  we  may  deduce  the  further  fact  that  the  discount  on 
the  gold  import  price  for  future  cables  is  equal  to  the  expense  of 
importing  an  amount  of  gold  equal  to  that  import  price,  plus 
interest  on  the  sum  of  the  import  price  and  the  expense  of  trans- 
portation at  the  London  rate  for  the  shipping  period.  It  will 
be  observed  that  the  future  cable  import  price  differs  from  the 
V  spot  cable  import  price  only  in  that  the  interest  loss  on  a  gold 
shipment  is  calculated  at  the  London  rate  instead  of  the  New 
York  rate. 

Relation  of  Specie  Points  to  Shipments. — Spot  and  future 
cable  rates  naturally  tend  to  preserve  their  parity  relation  even 
when  they  move  beyond  their  respective  specie  points,  and 
shipment  in  the  one  or  the  other  direction,  as  the  case  may  be, 
is  rendered  more  advantageous  than  either  form  of  exchange. 
So  long  as  they  remain  at  parity,  it  is  immaterial  to  arbitrageurs 
which  they  resort  to  as  an  offset  against  shipment,  since  they 
stand  to  realize  the  same  amount  of  profit  in  either  case.  If 
disparity  arises  when  the  rates  are  beyond  their  specie  points, 
arbitraging  can  be  profitably  undertaken  between  the  two  ex- 
changes, or  between  either  exchange  and  gold  consignment. 
But,  obviously,  the  operation  calculated  to  yield  the  best  results 
is  that  made  between  shipment  and  the  exchange  whose  rate  is 
farther  removed  from  its  specie  point.  Then,  too,  if  one  of  the 
exchanges  happens  to  be  beyond  while  the  other  is  still  within 
its  specie  point,  the  situation  is  unfavorable  for  gold  shipments, 
since  the  former  exchange  is  the  most  advantageous  method  of 
withdrawing  and  the  latter  of  remitting  funds  to  London,  while 
arbitraging  between  the  two  exchanges  is  the  most  profitable. 

In  determining  the  location  of  the  future  cable  specie  points, 
we  took  the  special  case  of  a  future  whose  term  was  coextensive 
with  the  shipping  period.  Other  futures  of  longer  or  shorter 
maturity  than  the  shipping  period  have  also  specie  points,  but 
as  they  are  not  as  often  resorted  to  in  connection  with  gold 


FUTURE  CABLE  EXCHANGE  67 

shipments,  their  gold  points  are  of  less  practical  importance. 
The  theoretical  specie  points  of  such  futures  are  determined  in 
the  manner  indicated  above  with  respect  to  the  specie  points  of 
futures  running  for  the  shipping  period,  except  that  an  additional 
interest  adjustment  must  be  made  to  allow  for  the  difference 
of  time  between  the  length  of  their  life  and  the  shipping  period. 

Future  Exchange  Traded  in  in  Both  Cities. — Dealings  take 
place  in  London  in  future  exchange  on  New  York,  in  precisely 
the  manner  described  with  reference  to  similar  transactions  in 
New  York.  The  rates  for  the  various  future  cable  maturities 
exhibit  a  tendency  to  parity  with  the  local  spot  cable  rate  analo- 
gous to  that  we  have  seen  prevail  in  the  New  York  market, 
but  the  parity  relation  of  the  future  and  spot  quotations  is  the 
reverse  of  that  in  New  York,  owing  to  the  fact  that  under  our 
supposition  London  rates  are  quoted  in  London  gold,  while 
New  York  rates  are  quoted  in  New  York  gold.  If  F  represents 
the  rate  of  a  future  cable  in  London  and  C  the  spot  cable  rate, 
then  F  equals 

C(i  +  /) 

when  parity  obtains  between  the  two  rates,  or  the  sum  of  the 
spot  price  and  interest  on  it  at  the  London  rate  for  the  period 
of  the  future,  discounted  at  the  New  York  rate  of  interest  for 
the  same  period;  and  conversely  C  equals 

F(i  +  i) 
(1  +  /)    ' 

or  the  sum  of  the  future  price  and  interest  on  it  at  the  New 
York  rate  for  the  period  of  the  future,  discounted  at  the  London 
rate  of  interest  for  the  same  period  {i  and  /  denote  the  interest 
rates  for  the  period  of  the  future  in  New  York  and  London  re- 
spectively).   Furthermore,  the  gold  export  point  of  a  future 


68  FOREIGN  EXCHANGE 

cable  in  London  running  for  the  time  it  takes  to  ship  gold  to 
New  York  is  (480  +  E)  (i  +  /),  or  the  sum  of  par  and  the  cost 
of  exporting  the  par  amount  of  gold,  or  480  grains,  plus  interest 
on  this  sum  at  the  London  rate  for  the  shipping  period;  while 
the  gold  import  rate  of  a  future  maturing  in  the  time  it  takes  to 
import  gold  from  New  York  is 

480^ 


(480  -i-e)  (i  +  i) 


which  makes  the  discount  on  the  import  rate  equal  to  the  cost 
of  importing  gold  amounting  to  the  import  rate,  plus  interest  at 
the  New  York  rate  for  the  importing  period  on  the  sum  of  the 
import  rate  and  the  foregoing  shipping  cost. 

Future  Cable  Rates  Expressed  in  Foreign  Gold. — The  dis- 
cussion of  future  cable  exchange  may  be  concluded  by  considering 
briefly  its  rate  in  London  when  expressed  by  the  second  system 
of  quotation.  Under  the  first  system,  when  exchange  rates  in 
London  are  quoted  in  terms  of  London  gold,  the  parity  rate  of 
a  ten-day  future  cable  is  (|^^  X  Ht  X  479)  grains,  assuming 
479  grains  to  be  the  spot  cable  rate,  and  -^ir  ^.nd  ^^^  to  be  the 
lo-day  interest  rates  in  London  and  New  York  respectively.  As 
the  ratio  represented  by  this  future  rate, 

480  grains  of  New  York  gold 
(m  X  rS?  X  479)  grains  of  London  gold  ' 

is  equal  to  the  ratio 

iiU  X  le-^  X  48itH)  grains  of  New  York  gold 

> 

480  grains  of  London  gold 

it  is  evident  that  under  the  second  system  of  quotation  the  rate 
for  the  future  is  (|^  X  Ht  X  481^!^)  grains,  which,  it  will 
be  noticed,  is  the  parity  rate  of  a  similar  future  in  New  York, 


FUTURE  CABLE  EXCHANGE  69 

provided  the  New  York  spot  cable  rate  is  at  parity  with  the 
London  spot  cable  rate  and  is  accordingly  quoted  481:^4-9-  grains 
(of  New  York  gold).  It  is  thus  apparent  that  with  the  first 
system  of  quotation  in  use  in  New  York  and  the  second  system 
in  London,  the  parity  quotations  in  the  two  centers  for  futures 
of  corresponding  maturity  are  identical,  provided  the  spot  cable 
rates  are  at  parity  with  each  other. 


J 


CHAPTER  V 

DEMAND  EXCHANGE 

Limitations  of  Cable  Transfer. — From  the  standpoint  of  the 
relative  time  of  the  two  deliveries,  we  have  so  far  had  to  do  with 
only  one  class  of  exchange,  the  cable  transfer,  the  distinguishing 
characteristic  of  which  is  the  simultaneous  delivery  of  the  two 
lots  of  gold,  either  in  the  present  or  at  a  stated  future  time. 

Before  the  era  of  cable  communication,  the  spot  cable  trans- 
fer was,  of  course,  a  physical  impossibility.  But  even  nowadays, 
when  the  cable  facilities  are  so  greatly  expanded,  the  use  of  this 
form  of  remittance  is  restricted,  for  the  most  part,  to  large  trans- 
actions, or  to  cases  where  speed  is  the  primary  consideration. 
Only  in  war,  when  traffic  on  the  seas  is  interrupted  and  the  ocean 
mail  service  is  too  unreliable,  does  spot  cable  exchange  become 
the  regular  means  of  remittance.  In  ordinary  times  the  great 
bulk  6i  the  exchanges  are  arranged  through  the  medium  of  the 
international  mails,  particularly  in  the  case  of  the  multitudinous 
small  remittances,  in  connection  with  which  the  cost  of  cabling 
is  out  of  all  proportion  to  the  amount  remitted. 

Demand  Exchange  Defined. — Known  as  "demand''  or  "sight 
exchange,"  remittance  by  mail  constitutes  the  second  general 
\  type  of  exchange.  It  is  the  most  important  type  because  it 
is  most  commonly  employed.  Its  fundamental  characteristic 
is  that  a  period  of  time  intervenes  between  the  two  deliveries. 
While  the  New  York  gold  is  delivered  immediately,  or  prac- 
tically so,  delivery  in  London  is  not  obtained  until  the  arrival 
from  New  York  of  a  written  order  for  it  in  the  shape  of  a  de- 
mand or  sight  draft,  or  bill  of  exchange.  To  take  a  simple  case, 
if  Adams  of  New  York  remits  to  London  by  effecting  a  de- 

70    . 


DEMAND  EXCHANGE  71 

mand  exchange  with  Barnard  of  New  York,  he  pays  the  latter 
immediately  the  stipulated  amount  of  New  York  gold,  and 
receives  from  him  a  draft  directing  Barnard's  debtor,  Carson, 
in  London  to  deliver  the  specified  amount  of  gold  to  Adams's 
creditor,  Dombey,  in  London.  Adams  posts  the  draft  by  the 
earliest  mail  to  Dombey,  and  as  soon  as  the  latter  receives  it, 
he  presents  it  to  Carson  and  gets  the  stated  amount  of  gold. 

Thus,  demand  or  sight  exchange  consists  of  the  exchange 
of  spot  gold  in  New  York  for  future  gold  in  London,  represented 
by  a  draft  made  payable  upon  arrival  in  that  city.  The  draft 
itself  is  customarily  referred  to  as  *'  demand  "  or  ^'  sight  exchange," 
and  is  regarded  as  being  bought  and  sold.  The  transaction  in 
the  example  above  would  be  commonly  described  as  Adams 
purchasing  demand  exchange  from  Barnard.  The  price  paid 
for  demand  exchange  is  known  as  the  ** demand"  or  "sight  rate." 
Under  the  first  system  of  quotation  it  indicates  the  amount  of 
New  York  spot  gold  which  is  given  in  exchange  for  480  grains 
of  London  gold  delivered  upon  the  arrival  of  the  next  mail  in 
London. 

Relation  of  Demand  and  Spot  Cable  Rates  at  Mutual  Parity. — 
From  the  foregoing  it  is  evident  that  the  buyer  of  demand  ex- 
change has  the  use  of  neither  lot  of  gold  for  the  space  of  the 
mailing  period,  while  the  seller  during  the  same  time  is  in  posses- 
sion of  both  the  buyer's  gold  in  New  York  and  his  own  in  London. 
But  the  buyer  suffers  no  loss  thereby,  for  the  seller  allows  him 
interest  in  the  shape  of  a  concession  from  the  prevailing  spot 
cable  rate.  Hence,  although  the  quotations  for  the  two  forms 
of  exchange  always  differ,  they  may  be  mutually  equivalent. 
As  a  matter  of  fact,  they  constantly  make  for  parity.  But  before 
discussing  this  tendency,  it  is  advisable  to  determine  the  exact 
relation  of  the  rates  when  they  are  thus  at  parity.  For  this 
purpose  we  shall  resort  to  our  usual  device  of  citing  concrete 
illustrations. 


72  FOREIGN  EXCHANGE 

A  T3rpical  Case. — Suppose  the  spot  cable  rate  at  the  moment, 
which  we  shall  assume  to  be  July  i,  is  481  grains,  that  the  time 
required  to  mail  a  draft  to  London  is  10  days,  and  that  the  London 
interest  rate  is  4%  per  annum,  or  -g-J-o  for  the  10  days.  As  al- 
ready explained,  a  person  in  New  York  who  has  a  debt  coming  due 
in  London  on  July  10,  can  provide  in  the  present  for  its  retire- 
ment on  the  due  date  by  purchasing  a  spot  cable  and  putting  the 
London  gold  out  at  interest  until  July  10.  But  he  has  the  al- 
ternative of  purchasing  and  mailing  a  demand  draft.  If  he  has 
recourse  to  the  former  method,  he  will  obviously  have  (|-§-^  X 
480)  grains  of  London  gold  on  July  10  to  devote  to  the  payment 
of  his  obligation  for  every  481  grains  of  New  York  gold  he  sur- 
renders in  exchange  on  July  i.  If  at  the  same  time  the  rate  for 
demand  exchange  is  such  that  for  481  grains  he  can  purchase  a 
demand  draft  for  (|^  X  480)  grains,  the  two  methods  of  remit- 
tance are  manifestly  equivalent.   As  this  demand  exchange  ratio  of 

481  grains  of  New  York  gold 
(wi  X  480)  grains  of  London  gold 

corresponds  to  the  ratio 

(If-;  X  481)  grains  of  New  York  gold 
480  grains  of  London  gold 

it  is  apparent  that  as  customarily  quoted  the  demand  rate  equiv- 
alent to  the  spot  cable  rate  of  481  grains  is  (Hf  X  481)  grains. 
That  is  to  say,  the  so-called  ''demand  parity"  of  the  current 
j  spot  cable  price  is  equal  to  that  cable  price  discounted  at  the 
London  interest  rate  for  the  lo-day  mailing  period. 

A  Sale  of  Exchange. — This  same  relationship  between  the 
two  rates  when  at  mutual  parity  holds  true  in  the  case  of  a  sale 
of  exchange.  Let  us  take  a  person  in  New  York  who  will  come 
into  possession  of  a  quantity  of  London  gold  in  10  days,  or  on 


DEMAND  EXCHANGE  73 

July  10.  To  sell  on  July  i  a  spot  cable  against  this  future  gold 
he  must  obviously  borrow  in  London  a  sum  equal  to  (|^f  X  480) 
grains  for  every  480  grains  he  will  receive.  The  sale  of  this 
amount  of  cables  at  the  rate  of  481  grains  yields  him  imme- 
diately in  New  York  (f^f  X  481)  grains.  Thus  by  marketing 
spot  cables  on  July  i,  he  acquires  (|^f  X  481)  grains  of  New 
York  gold  against  every  480  grains  of  London  gold  he  will  re- 
ceive and  in  turn  deliver  on  July  10.  But  as  he  can  obtain 
precisely  the  same  result  by  selling  demand  exchange  at  the 
rate  of  (|^^  X  481)  grains,  it  is  manifest  that  this  rate  is  the 
demand  parity  of  the  spot  cable  rate  of  481  grains  in  the  case 
of  a  sale  as  well  as  a  purchase  of  exchange. 

We  have,  therefore,  established  the  general  proposition  that 
when  demand  exchange  is  at  parity  with  spot  cables  its  rate  is 
equal  to  the  cable  quotation  discounted  at  the  London  interest 
rate  for  the  time  it  takes  to  mail  a  draft  to  London.  To  put  the 
formula  in  the  form  of  an  algebraic  equation,  if  d  denotes  the 
demand  price,  c  the  spot  cable  price,  and  /  the  London  interest 
rate  for  the  mailing  period,  d  equals 


(1  +  /) 


Conversely,  as  c  equals  d{i  -\- 1),  the  cable  parity  of  the  demand 
rate  is  the  demand  quotation,  plus  interest  on  it  at  the  London 
rate  for  the  mailing  period.  Finally,  since  (c—d)  equals  {I  X  d)j 
the  parity  difference,  or  ''spread,"  as  it  is  usually  called,  between 
the  spot  cable  and  demand  prices  amounts  to  interest  on  the 
demand  price  at  the  London  rate  for  the  mailing  period. 

Demand  Exchange  Tends  to  Parity  with   Spot   Cables. — 

That  the  two  rates  tend  to  keep  their  parity  relationship  is  shown 
by  the  following  examples  illustrating  opposite  cases  of  disparity. 
Assume  the  conditions  of  the  preceding  example,  except  the 
rate  for  demand  exchange,  which  is  now  taken  to  be  480  grains. 


74  FOREIGN  EXCHANGE 

Inasmuch  as  the  demand  parity  of  the  cable  rate  of  481  grains  is 
(Ht  X  481)  or  48of  fl  grains,  the  actual  demand  quotation  is  be- 
low this  parity  rate  by  |f  f  of  a  grain,  and  demand  exchange  is  ac- 
cordingly cheaper  than  spot  cables.  Under  those  circumstances 
the  more  discriminating  remitters  will  purchase  demand  drafts 
instead  of  cables,  while  the  shrewder  sellers  of  exchange  will 
make  their  offerings  in  the  form  of  cables  rather  than  demand 
drafts.  This  readjustment  in  the  relation  of  the  demand  and 
supply  of  each  class  of  exchange  will  receive  further  impetus 
from  the  operations  of  arbitrageurs.  Against  lo-day  loans  con- 
tracted in  London  they  will  sell  cable  transfers,  and  out  of  the 
proceeds  they  will  purchase  and  remit  demand  drafts  to  London 
to  liquidate  the  loans.  Their  profit  will  amount  to  ^^  of  a 
grain  of  New  York  gold  for  every  (f^f-  X  480)  grains  of  cables 
they  sell;  or,  what  amounts  to  the  same  thing,  for  every  480 
grains  of  demand  exchange  they  buy. 

Thus,  when  demand  exchange  is  quoted  below  parity  with 
\  spot  cables,  the  demand  for  it  increases  and  the  supply  decreases; 
while  the  demand  for  spot  cables  declines  and  the  supply  grows 
larger.  The  demand  price,  accordingly,  rises  and  the  cable 
price  falls.  The  spread  between  them  contracts,  and  when  it 
just  equals  interest  on  the  demand  price  at  the  London  rate  for 
the  mailing  period,  the  quotations  are  in  a  position  of  mutual 
parity. 

Difference  Less  than  Parity  Spread. — The  same  tendency 
toward  equivalence  is  displayed  by  the  two  rates  in  the  reverse 
case  of  disparity,  when  the  margin  of  difference  between  them 
is  less  than  the  parity  spread.  For  instance,  let  us  assume  that 
the  demand  rate  is  480^^  grains,  when  the  cable  rate,  the  London 
rate  of  interest,  and  the  length  of  the  mailing  period  are  the 
same  as  in  the  preceding  example.  Since  the  demand  price 
now  exceeds  the  demand  parity  of  480IJ?  grains  by  y.loa  of  a 
grain,  demand  exchange  is  the  more  costly  means  of  remittance. 


DEMAND  EXCHANGE  75 

Remitters  accordingly  will  be  inclined  to  purchase  cable  trans- 
fers in  preference  to  demand  drafts,  while  sellers  of  exchange 
will  be  disposed  to  offer  demand  drafts  rather  than  cables.  The 
existence  of  the  disparity  will  also  prompt  arbitrageurs  to  market 
demand  exchange,  purchase  cables  from  the  proceeds,  and  lend 
out  the  London  gold  until  the  arrival  of  their  drafts.  The  sum 
they  will  realize  will  amount  to  y.lW  of  a  grain  on  every  (f  f  f  X 
480)  grains  of  cable  transfers  they  purchase,  or  on  every  480  grains 
of  demand  exchange  they  sell  at  the  same  time. 

Thus,  when  the  difference  between  the  existing  rates  is  less 
than  the  parity  spread,  the  demand  for  spot  cables  tends  to 
expand  and  the  supply  to  decline,  while  the  demand  for  demand 
exchange  tends  to  fall  off  and  the  supply  to  increase.  There 
follows,  in  consequence,  an  advance  in  the  cable  rate  and  a  de- 
cline in  the  demand  rate;  and  as  the  rates  move  away  from 
each  other,  the  existing  spread  widens  until  it  coincides  with 
the  parity  spread,  in  which  case  the  two  forms  of  exchange  are 
in  equilibrium. 

It  follows,  therefore,  that  the  rates  for  demand  and  spot  cable 
exchange  are  constantly  drawn  to  a  parity  relationship.  Any 
departure  from  this  condition  at  once  liberates  forces  which 
operate  to  correct  the  disparity  and  re-establish  the  equilibrium. 

Parity  Relationship  Realized. — Of  all  the  parity  relationships 
which  one  class  of  exchange  on  London  tends  to  maintain  with 
the  other  classes,  that  between  spot  cables  and  demand  bills  is 
realized  in  actual  experience  in  the  greatest  degree.  Dealings 
in  these  two  forms  of  remittance  are  larger  and  more  frequent 
than  in  the  others,  and  conditions  are,  therefore,  more  favorable 
for  big  traders  to  make  the  most  of  any  disparity  between  them 
the  moment  it  arises.  Accordingly,  as  either  rate  advances  in 
response  to  an  increased  demand,  the  other  rises  almost  simul- 
taneously; and  as  the  one  falls  under  pressure  of  heavier  offer- 
ings, the  other  follows  hard  on  its  heels.    As  the  cable  market 


V 


76  FOREIGN  EXCHANGE 

is,  however,  less  active  as  a  rule  than  the  demand  market,  the 
jCable  rate  is  controlled  by  the  demand  quotation,  so  that  read- 
justment to  mutual  parity  is  mostly  brought  about  by  a  move- 
ment in  the  former.  The  rates,  however,  do  not  tend  to  parallel 
each  other's  movements  absolutely,  since  they  change  to  a 
certain  degree  in  relation  to  each  other.  The  parity  spread 
between  them  widens  or  contracts  as  the  London  interest  rate 
or  the  length  of  the  mailing  period  increases  or  decreases. 

The  purchaser  of  demand  exchange,  in  addition  to  perform- 
ing an  exchange,  makes  an  advance  to  the  seller.  He  loans 
New  York  gold  and  is  repaid  in  London  gold,  with  interest  com- 
puted at  the  London  rate.  As  the  interest  rate  on  such  advances 
necessarily  varies  with  the  relative  credit  standing  of  the  bor- 
rowers, demand  exchange  must  needs  possess  a  plural  quotation. 
Sellers  enjoying  a  higher  credit  rating  obtain  a  higher  price  for 
their  drafts.  In  our  general  discussion  of  demand  exchange, 
however,  we  are  only  concerned  with  the  prime  grade  of  bills, 
put  out  by  drawers  of  first-class  credit  and  commanding  the 
highest  market  price. 

Gold  Export  Point  of  Demand  Exchange.— Since  the  demand 
rate  moves  up  and  down  with  the  spot  cable  quotation,  it  is 
necessarily  confined  within  limits  above  and  below  par,  which 
are  its  specie  points,  or  the  points  at  which  it  is  respectively 
equivalent  to  gold  exporting  and  gold  importing.  Considering 
first  the  export  point  and  assuming  that  a  shipment  of  gold  to 
London  can  be  completed  in  the  time  it  takes  to  mail  a  draft, 
as  is  substantially  the  case  in  actual  practice,  let  us  suppose  that 
the  demand  rate  of  exchange  is  48  ij  grains  and  the  expense  of 
shipping  480  grains  is  1 1-  grains.  In  that  situation  the  purchaser 
of  demand  exchange  and  the  exporter  of  gold  fare  equally  well, 
since  both  will  come  into  possession  of  480  grains  at  the  end  of 
the  mailing  or  shipping  period  for  every  48 1|  grains  they  part 
with  now  in  New  York.     Remittance  by  demand  exchange  being 


DEMAND  EXCHANGE  77 

thus  equivalent  to  shipping  gold,  48 1|-  grains  is  the  demand  gold 
export  point.  It  will  be  observed  that  the  premium  on  this 
export  rate  contains  no  element  of  interest,  but  is  merely  equal 
to  the  cost  of  shipping  480  grains. 

In  general  the  demand  export  rate  is  equal  to  par  plus  the 
cost  of  shipping  the  par  amount  of  gold,  or,  expressed  algebra- 
ically, it  is  equal  to  (480  +  e)  grains.  When  the  rate  is  drivenN^ 
above  this  specie  point,  shipment  is  rendered  cheaper  than  the 
purchase  of  demand  exchange,  and  arbitrageurs  find  it  profitable 
to  sell  demand  exchange  and  forward  an  equal  amount  of  gold 
as  cover  for  the  drafts,  as  they  stand  to  net  the  difference  be- 
tween the  quoted  rate  and  the  export  point  for  every  480 
grains  of  exchange  they  sell  and  for  every  480  grains  of  the  metal 
they  ship.  < 

Parity  of  Export  Rates. — The  gold  export  rate  for  demand 
exchange  is  the  parity  of  the  gold  export  rate  for  spot  cables,  ^ 
and  also  of  the  gold  export  rate  for  future  cables  deliverable  in 
the  shipping  period.  This  is  evident  from  the  following  example. 
In  addition  to  the  conditions  assumed  above,  suppose  that  10 
days  are  necessary  either  to  ship  gold  or  mail  a  draft  to  London, 
and  that  the  interest  rate  for  the  period  is  -^^  in  London  and  5  J-j- 
in  New  York.  Under  those  circumstances  the  gold  export  rate 
for  spot  cables  is  (f^  X  481 1^)  grains  [(480  -{-  e)  {1  +  /)],  which 
is  manifestly  the  parity  of  the  demand  export  rate  of  481!^  grains 
[c  =  d{i  +  /)].  Thus  the  rates  for  both  classes  of  exchange 
tend  to  reach  their  respective  export  points  concurrently.  Since 
future  cables  deliverable  in  the  shipping  period  make  for  their 
export  points  simultaneously  with  spot  cables,  all  three  rates 
tend  to  arrive  at  their  respective  export  points  at  the  same 
time.' 


•  Inasmuch  as  demand  and  future  cable  exchange  tend  to  parity  with  spot 
cables,  they  necessarily  tend  to  parity  with  each  other.  When  this  parity 
relation  obtains  between  them,  the  future  cable  price  is  equal  to  the  sum  of  the 


78  FOREIGN  EXCHANGE 

Arbitrageurs  have,  consequently,  the  choice  of  selling  spot 
cables,  future  cables,  or  demand  exchange  against  gold  shipments. 
If  the  rates  for  all  three  forms  of  exchange  are  at  parity  to  each 
other  when  quoted  above  their  export  points,  it  is  immaterial 
which  type  of  exchange  they  sell,  as  they  stand  to  realize  the 
same  amount  of  profit  in  any  case.  Frequently,  however,  the 
rates  show  an  appreciable  divergence  from  parity,  each  as  regards 
the  other  two,  in  which  event  arbitrageurs  sell  the  dearest  form 
of  exchange  against  their  gold  consignments. 

Gold  Import  Point  of  Demand  Exchange. — In  considering 
the  gold  import  rate  for  demand  exchange,  let  us  assume  that  the 
cost  of  importing  480  grains  is  i  J  grains,  that  10  days  are  con- 
sumed in  mailing  a  draft  to  London  or  in  importing  gold  from 
London,  and  that  the  lo-day  interest  rate  is  ^Ju"  i^^  New  York 
and  -qI-q  in  London.  Under  those  conditions,  if  a  person  in 
New  York  orders  the  gold  he  has  in  London  shipped  home  on 
July  I,  he  will  have  480  grains  in  New  York  on  July  10  for  every 
48 1 J  grains  he  in  effect  gives  up  now  in  London,  the  difference 
of  i|^  grains  being  expended  in  paying  the  transportation  charges. 

Suppose,  however,  that  he  transfers  his  gold  to  New  York 
by  sale  of  demand  exchange.  As  he  will  not  make  delivery  in 
London  until  his  draft  arrives  there  on  July  10,  the  481^  grains 
he  has  in  that  city  will  have  increased  by  then  through  interest 
accrual  to  (f^  X  481^^)  grains.  He  can,  accordingly,  sell  this 
amount  of  demand  exchange  on  July  i.  Assume  that  he  re- 
ceives (12  f  X  480)  grains  for  it.  As  this  sum  put  out  at  interest 
until  July  10  will  amount  to  480  grains,  it  is  evident  that  the 
sale  of  demand  exchange  at  the  above  rate  is  equivalent  to  the 


demand  price  and  interest  on  it  at  the  New  York  rate  for  the  mailing  period 
[f  =  d{i  -{-  i)];  and,  conversely,  the  demand  price  is  equal  to  the  future 
cable  price  discounted  at  the  New  York  rate  of  interest  for  the  mailing  period 

[d  =  — - —  1. 


DEMAND  EXCHANGE  79 

importation  of  gold,  since,  as  in  the  latter  case,  he  will  have  480 
grains  in  New  York  on  July  10  for  every  481 J  grains  he  has  in 
London  on  July  i.     Moreover,  as  this  ratio  of 

(f  ¥T  X  480)  grains  of  New  York  gold 
(Iw  X  481!^)  grains  of  London  gold 

at  which  he  markets  the  exchange  is  equal  to  the  ratio 

480' 
(f  ?i  X  1^  X  -z-t)  grains  of  New  York  gold 
451^ 

480  grains  of  London  gold 

the  demand  rate  as  usually  quoted  is 

480^ 
(1^  X  «i  X  -—;)  grains, 
4»i^ 

which  is  manifestly  the  gold  import  rate  of  the  moment. 

In  general,  then,  the  gold  import  rate  for  demand  exchange 
is  equal  to  the  square  of  par  divided  by  the  sum  of  the  following 
four  quantities: 

1.  The  par  of  480  grains. 

2.  The  cost  of  importing  480  grains. 

3.  Interest  at  the  New  York  rate  for  the  importing  period 

on  the  sum  of  the  two  preceding  quantities. 

4.  Interest  at  the  London  rate  for  the  mailing  period  on 

the  sum  of  the  three  preceding  quantities. 

Reduced  to  an  algebraic  expression,  the  demand  import  rate  equals 

480^ . 

(480  + £)  (i  +  i)  (1  +  /)* 

From  this  formula  we  deduce  the  further  fact  that  the  discount 
on  the  gold  import  rate  is  equal  to  the  sum  of  the  following 
three  quantities: 


8o  FOREIGN  EXCHANGE 

1.  Interest  at  the  New  York  rate  for  the  shipping  period 

on  the  import  rate. 

2.  Interest  at  the  London  rate  for  the  mailing  period  on  the 

sum  of  the  import  rate  and  the  first  quantity. 

3.  The  cost  of  importing  an  amount  of  gold  equal  to  the  sum 

of  the  import  rate  and  the  first  and  second  quantities. 

Demand  Rate  below  Import  Point. — When  the  demand  rate 
falls  below  its  import  point,  it  becomes  more  advantageous  to 
import  gold  from  London  than  to  sell  demand  exchange.  Arbi- 
trageurs are  at  the  same  time  afforded  the  opportunity  of  making 
a  profit  by  purchasing  demand  exchange  against  the  simultaneous 
importation  of  gold.  In  performing  the  transactions  they  borrow 
both  in  New  York  and  London.  The  drafts  they  purchase  will 
meet  the  loans  in  London,  while  the  gold  they  import  will  cover 
the  loans  in  New  York  and  leave  a  balance  for  profit. 

Under  the  conditions  assumed  the  spot  cable  import  rate  is 

480^ 

(J^T  X  -r-)  grains, 

4»i^ 

480^ 
I.e., 


(480  +  E)  (i  +  i) 

As  this  is  equal  to  the  demand  import  rate  plus  interest  on  it  for 
the  mailing  period  at  the  London  rate,  it  is  evident  that  the  two 
rates  are  at  parity.  Both  forms  of  exchange,  accordingly,  tend 
to  arrive  at  their  import  points  together.  Moreover,  since 
future  cables  maturing  in  the  importing  period  tend  to  touch 
their  gold  import  point  of 

480^ 

(480  +  £)(!  +  /) 

at  the  same  time  as  the  spot  cable  rate  reaches  its  import  rate, 
I  all  three  classes  of  exchange  tend  to  reach  their  respective  im- 
port points  simultaneously.     If  the  three  rates  maintain  their 


DEMAND  EXCHANGE  8l 

parity  relationship  as  they  decline  below  their  import  points,  it 
does  not  matter  which  form  of  exchange  arbitrageurs  purchase 
against  the  importation  of  gold,  as  they  will  realize  the  same 
amount  of  profit.  But  if  disparity  arises  between  the  rates  as 
they  fall  below  their  respective  import  points,  it  will  naturally 
advantage  arbitrageurs  to  purchase  the  cheapest  form  of  ex- 
change to  offset  their  gold  importations. 

Demand  Exchange  Transacted  in  Both  Centers. — The  Lon- 
don market,  of  course,  deals  in  demand  exchange  as  well  as  the 
New  York  market.  There  demand  exchange  consists  of  the 
present  delivery  of  London  gold  against  the  receipt  of  a  draft 
calling  for  dehvery  of  gold  in  New  York  upon  presentation  of  the 
draft  in  the  latter  city.  London  demand  exchange  is,  accordingly, 
the  reverse  of  demand  exchange  in  New  York,  and  the  price  it 
tends  to  maintain  is  equal  to  the  price  for  spot  cable  transfers 
on  New  York  discounted  at  the  New  York  rate  of  interest  for 
the  period  in  which  the  draft  can  be  mailed  to  New  York.  If 
D  represents  this  parity  rate  for  demand  exchange,  C  the  pre- 
vailing spot  cable  rate,  and  i  the  New  York  interest  rate  for  the 
mailing  period,  D  equals 

C 

and  conversely,  C  equals  D  {i  -\-  i)- 

The  specie  points  for  demand  exchange  on  New  York  in 
London  are  determined  in  a  manner  analogous  to  that  by  which 
the  specie  points  are  fixed  in  New  York  for  demand  exchange  on 
London.  With  E  representing  the  cost  of  shipping  480  grains 
to  New  York,  the  gold  export  point  for  demand  exchange  in 
London  is  (480  +  E),  which  is  the  parity  of  the  spot  cable 
export  rate  of  (480  •\-  E)  (i  -f-  i).^    In  a  similar  manner  if  e 

'  In  this  and  the  following  section,  i  represents  the  New  York  interest 
rate  for  the  period  necessary  either  to  ship  gold  or  mail  a  draft  from  London  to 
6 


82  FOREIGN  EXCHANGE 

represents  the  expense  of  importing  480  grains  from  New  York, 
the  gold  import  rate  for  demand  exchange  in  London  is 

480^ 
(480  +  e)   (i  +  /)   (i  +  i) 

which,  again,  is  the  parity  of  the  spot  cable  import  rate  of 

480^ 
(480  +  ^)   (1  +  /)' 

Demand  exchange  in  each  center  tends  to  parity  with  local 
spot  cables.  Inasmuch  as  spot  cables  in  one  city  tend  to  parity 
with  spot  cables  in  the  other,  it  follows  that  demand  exchange 
in  either  place  tends  to  parity  with  both  spot  cables  and  demand 
^exchange  in  the  other,  for  things  equal  to  the  same  thing  or  equal 
things  are  equal  to  each  other. 

Demand  Exchange  under  the  Second  System  of  Quotation. — 

There  is  yet  to  be  considered  the  rate  for  demand  exchange  in 
London  when  exchange  quotations  are  expressed  in  terms  of 
New  York  gold,  or  according  to  the  second  system  of  quotation. 
As  has  been  pointed  out  in  the  preceding  section,  under  the  first 
system  of  quotation,  when  the  rates  refer  to  London  gold  and 
are  at  parity,  D  equals 

C 

But  as  the  ratio  expressed  by  this  rate,  namely, 

480  grains  of  New  York  gold 

C 

-  grains  of  London  gold 


(i  +  i) 
is  equal  to  the  ratio 

New  York,  while  /  represents  the  London  interest  rate  for  the  period  it  takes 
to  ship  gold  from  New  York  to  London. 


DEMAND  EXCHANGE  83 

480^  (i  +  i) 

j; grains  of  New  York  gold 

480  grains  of  London  gold 

the  rate  under  the  second  system  of  quotation  is 

480^  (i  +  i) 
C 

that  is  to  say,  the  demand  parity  rate  is  then  equal  to  the  cable  price, 

480' 
i.e.,  —pr-  under  the  second  system  of  quotation, 

plus  interest  on  it  at  the  New  York  rate  for  the  mailing  period. 
When  exchange  rates  in  New  York  are  expressed  by  the  first 
method  of  quotation  and  those  in  London  by  the  second  method 
of  quotation — that  is,  when  rates  in  both  centers  are  expressed 
in  terms  of  New  York  gold — the  spot  cable  prices  in  both  places 
tend  to  an  identical  figure,  as  explained  in  Chapter  III;  while 
the  demand  quotation  rules  below  this  figure  in  New  York  and 
above  it  in  London. 

Turning  now  to  the  specie  points  for  demand  exchange  in 
London  when  quoted  in  terms  of  New  York  gold,  we  have  learned 
that  under  the  first  system  of  quotation  the  export  point  is 
equal  to  (480  +  £).     As  the  ratio  of 

480  grains  of  New  York  gold 
(480  +  E)  grains  of  London  gold 

denoted  by  this  rate  is  equal  to  the  ratio 
480 


(480 +£) 


grains  of  New  York  gold 


480  grains  of  London  gold 
the  same  export  rate  under  the  second  system  of  quotation  is 


84  FOREIGN  EXCHANGE 

480^ 

(480  +  E)  ' 

which  is  below  the  par  of  480  grains  by  an  amount  equal  to  the 
expense  of  shipping  a  quantity  of  gold  to  New  York  equal  to  the 
rate,  as  is  evident  from  the  following  equation: 


0+£)C-^)=4^°- 


480/  \48o  +  £> 

As  for  the  demand  import  point  in  London  when  expressed 
in  terms  of  New  York  gold,  we  have  learned  that  under  the 
first  system  of  quotation  it  is  equal  to 

480* 


(480  +  e)  (i  +  /)  (i  +  i) 
or  given  in  full,  to  the  ratio 

480  grains  of  New  York  gold 

grains  of  London  gold. 


(480  +  e)  (i  +  i)  (i  +  /) 

As  this  ratio  is  equal  to 

(480  -\-  e)  (i  +  /)  (i  +  ^*)  grains  of  New  York  gold 
480  grains  of  London  gold 

the  gold  import  rate  under  the  second  system  of  quotation  is  (480 
-j-  e)  (i  +  /)  (i  +  i),  or  the  sum  of  the  following  three  quantities: 

1.  The  sum  of  par  and  the  cost  of  importing  480  grains  from 

New  York. 

2.  Interest  on  this  first  quantity  at  the  London  rate  for  the 

shipping  period. 

3.  Interest  on  the  sum  of  these  two  quantities  at  the  New 

York  rate  for  the  mailing  period  to  New  York. 


DEMAND  EXCHANGE  85 

Future  Demand  Exchange. — In  our  discussion  of  demand  ex- 
change we  have  been  concerned  with  the  spot  or  prompt  variety, 
the  distinguishing  feature  of  which  is  the  immediate  payment  and 
delivery  of  the  draft.  But  this  species  of  remittance  is  also  dealt 
in  for  future  delivery.  Suppose  a  person  has  a  debt  falling  due  in 
London  90  days  hence.  While  he  can  protect  himself  against  an 
advance  in  exchange  rates  during  this  time  by  immediately  pur- 
chasing a  future  cable  transfer  maturing  in  90  days,  he  can  ac- 
complish the  same  end  by  buying  at  once  future  demand  exchange 
running  for  80  days,  assuming  that  it  will  take  the  10  days  follow- 
ing to  send  the  draft  to  London.  At  the  end  of  the  80  days,  he 
will  pay  for  and  receive  the  draft,  which  he  will  straightway  remit 
to  London  in  discharge  of  his  debt.  Thus,  future  demand  ex- 
change consists  essentially  of  the  exchange,  at  a  rate  fixed  in  the 
present,  of  New  York  gold  delivered  at  a  stated  future  time,  for  ] 
London  gold  delivered  at  the  end  of  the  ensuing  mailing  period. 


CHAPTER  VI 

LONG  EXCHANGE 

Long  Exchange  Defined. — The  third  and  last  form  of  ex- 
change, co-ordinate  with  cable  transfers  and  demand  bills,  is 
called  '^ong"  or  *'time  exchange."  It  differs  from  demand  re- 
mittance only  in  that  the  interval  between  the  New  York  and 
London  deliveries  is  longer  than  in  the  case  of  demand  exchange, 
exceeding  the  time  required  to  remit  a  draft  from  New  York  to 
London  by  a  certain  number  of  days  or  months,  usually  by  30, 
60,  or  90  days,  or  by  4,  5,  or  6  months.  Spot  gold  is  delivered  in 
New  York  in  return  for  a  draft  on  a  party  on  the  other  side  which 
calls  for  the  delivery  of  a  stated  amount  of  gold  in  London  at  a 
more  or  less  fixed  future  date.  The  draft  itself  is  referred  to  as 
"long"  or  "time  exchange,"  and  the  rate  or  price  at  which  it  is 
quoted  denotes,  under  the  first  system  of  quotation,  the  amount  of 
New  York  spot  gold  given  in  exchange  for  480  grains  of  the  face 
amount  of  the  draft,  that  is,  for  480  grains  of  London  gold  de- 
livered on  the  draft  when  due. 

Long  exchange  for  the  most  part  has  its  origin  in  merchandise 
exports.  When  an  American  merchant  sells  a  bill  of  goods  to  a 
British  importer,  it  is  usually  with  the  understanding  that  he 
draw  on  the  importer  (or  his  bank)  a  long  bill  of  exchange,  pay- 
able in  London,  for  the  invoice  value  of  the  merchandise.  The 
bill  is  generally  made  out  to  mature  a  specified  time  "  after  sight," 
that  is,  after  it  has  been  sent  across  and  been  presented  to  the  im- 
porter and  he  has  agreed  to  pay  it  by  writing  across  its  face  the 
word  "Accepted"  over  his  signature.  The  exact  period  for  which 
the  bill  is  drawn  in  any  particular  case  depends  on  the  length  of 
the  credit  the  American  exporter  is  extending  to  his  customer. 
The  terms  are  usually  such  as  to  allow  the  foreign  importer  ample 

86 


LONG  EXCHANGE  87 

time  in  which  to  receive  and  perhaps  even  to  dispose  of  the 
goods  before  the  draft  matures.  But  while  the  shipper  thus  ad- 
vances credit,  he  is  by  no  means  obliged  to  wait  for  his  money 
returns  until  the  maturity  of  the  bill,  as  he  can  reimburse  himself 
immediately,  or  at  any  time  during  the  life  of  the  bill,  by  selling 
or  discounting  it  either  in  New  York  or  London. 

Methods  of  Handling  Long  Bills. — Suppose  the  bill  is  a  90- 
day  sight  bill  for  1,000  ounces.  If  he  follows  the  usual  practice, 
he  makes  it  out  in  favor  of  himself,  since  by  indorsing  it  in  that 
form  he  renders  it  payable  to  bearer  and  can,  therefore,  sell  it  to 
the  highest  bidder,  should  he  desire  to  dispose  of  it  in  advance  of 
maturity.  Let  us  first  assume,  however,  that  he  has  decided  to 
hold  the  bill  until  it  is  due.  Under  those  circumstances  he  for- 
wards it  at  the  earliest  opportunity  to  his  British  customer  and 
obtains  his  acceptance.  When  accepted  the  bill  has  the  legal 
force  of  a  promissory  note,  and  runs  thereafter  for  90  days.' 
Accordingly,  if  we  suppose  that  10  days  were  required  to  mail  the 
draft  to  London,  the  currency  of  the  bill,  or  its  "tenor"  or  "us- 
ance," as  it  is  sometimes  called,  will  extend  for  a  total  of  100  days 
from  the  day  the  bill  was  drawn. 

Receiving  the  accepted  bill,  which  is  now  styled  an  "accept- 
ance," the  American  shipper  holds  it  unt^il  he  must  mail  it  again 
to  the  other  side  to  present  it  for  payment  on  the  due  date.  If  we 
take  that  time  to  be  ten  days  prior  to  the  bill's  maturity,  the  bill 
is  then  obviously  equivalent  to  a  demand  draft  for  1,000  ounces 
minus  the  stamp  tax  of  J  ounce  he  will  pay  the  British  Govern- 
ment. (A  tax  of  2^%  of  ths  f2.ce  amount  is  levied  on  all  bills  of 
exchange  of  more  than  3  days'  sight.)  He  can  accordingly  dis- 
pose of  the  bill  in  New  York  as  demand  exchange  at  the  prevailing 


^  Debtors  in  Great  Britain  are  allowed  3  days  of  grace  on  their  payments, 
of  which  they  invariably  take  full  advantage,  but  to  avoid  awkward  calcula- 
tions in  our  illustrations,  we  shall  pay  no  attention  to  this  added  period  in  the 
present  chapter. 


88  FOREIGN  EXCHANGE 

rate;  or,  if  he  has  kept  it  with  an  agent  on  the  other  side,  he  can 
sell  his  own  demand  drafts  against  its  coming  encashment.  In 
either  case  he  has  waited  for  his  reimbursement  90  days  from  the 
day  he  consigned  his  shipment  and  drew  the  bill.  Or,  if  he  pre- 
fers, he  may  extend  his  waiting  an  additional  10  days  until  the 
draft  is  actually  collected,  and  then  sell  a  cable  transfer.  But 
whether  he  has  sold  demand  or  cable  exchange,  he  has  run  the 
risk  of  a  loss  from  a  possible  drop  in  the  rates  of  exchange  during 
the  90  or  100  days.  He  might,  however,  have  guarded  against 
this  contingency  by  selling,  as  soon  as  he  had  issued  the  long  bill, 
future  demand  exchange  maturing  at  the  end  of  90  days,  or  future 
cable  exchange  maturing  at  the  end  of  100  days. 

An  Alternative  Procedure. — But  the  American  exporter  can 
ordinarily  employ  his  funds  to  better  advantage  than  to  have 
them  locked  up  in  the  long  bill.  Accordingly,  he  usually  loses  no 
\  time  in  reimbursing  himself  for  his  merchandise  sale  by  discount- 
ing the  draft.  In  actual  practice  he  has  no  alternative  but  to  sell 
the  draft  to  a  foreign  exchange  banker  in  New  York,  who,  in  turn, 
negotiates  it  in  London,  the  ultimate  market  for  the  bill.  But  in- 
asmuch as  we  are  still  leaving  the  middleman  out  of  account,  we 
shall  assume  that  the  exporter  is  in  a  position  to  place  his  bill 
directly  with  a  London  as  well  as  a  New  York  bank. 

Suppose  first  that  he  elects  to  sell  his  90-day  sight  bill  in  Lon- 
don, and  at  the  same  time  refuses  to  enter  into  any  speculative 
commitment  in  connection  with  the  transaction.  He  proceeds 
in  that  case  as  follows:  He  first  has  a  X-ondon  discount  bank 
cable  him  the  rate  at  which  it  agrees  to  purchase  the  draft  upon 
its  arrival  in  London  10  days  hence.  By  this  arrangement  he 
protects  himself  against  loss  from  a  possible  advance  in  the  Lon- 
don discount  rate  during  the  bill's  voyage  across.  The  rate  per- 
taining to  bills  sold  thus  for  forward  delivery  is  commonly  known 
as  the  rate  "to  arrive,''  in  contradistinction  to  the  quotation 
applying  to  bills  for  immediate  delivery,  or  the  so-called  "spot 


LONG  EXCHANGE  89 

rate."  We  shall  suppose  that  the  rate  "to  arrive"  which  the 
exporter  is  offered  and  accepts  by  cable  for  his  bill  is  3%  per  an- 
num on  the  face  amount.  (For  the  sake  of  simpKcity  we  shall 
follow  in  the  illustrations  of  this  chapter  the  usual  banking  prac- 
tice of  figuring  interest  on  long  bills  on  the  basis  of  banker's  in- 
stead of  "true"  discount.)  ) 

In  addition  to  the  interest  discount,  there  will  be  deducted  '• 
from  the  amount  of  the  bill  in  London  the  British  stamp  tax, 
which  for  the  sake  of  convenience  in  computation  we  shall  assume 
to  be  i%  of  the  face  amount,  or  at  the  annual  rate  of  1%.  To  all 
intents  and  purposes,  then,  the  bill  will  be  discounted  at  a  total 
per  annum  rate  of  4%,  or  the  flat  rate  of  y^,  making  the  net 
amount  the  exporter  will  realize  990  ounces.  This  sum  represents, 
therefore,  the  amount  of  demand  exchange  he  can  sell  in  New 
York  immediately  he  has  completed  arrangements  for  the  sale 
of  his  long  bill  in  London;  for  his  demand  draft  will  be  carried  to 
London  by  the  same  vessel  as  his  long  bill  and  will  be  met  with 
its  proceeds.  If  the  price  he  gets  for  the  demand  draft  is  481 
grains,  his  immediate  receipts  in  New  York  from  his  merchandise 
sale  will  amount  to  992^^  ounces.  In  fixing,  therefore,  upon  the 
price  in  London  gold  at  which  he  should  sell  his  goods,  he  had  to 
take  into  account  the  two  factors  of  the  London  discount  rate 
"to  arrive"  for  his  90-day  sight  bill,  including  the  cost  of  the  ' 
bill  stamp,  and  the  prevailing  price  for  demand  exchange. 

Upon  arriving  in  London  and  being  accepted  by  the  importer, 
the  90-day  bill  is  delivered,  with  the  tax  stamp  affixed,  to  the  bank 
which  has  agreed  to  purchase  it  at  3%  per  annum,  and  the  pro- 
ceeds of  the  discount,  minus  the  cost  of  the  bill  stamp,  are  applied 
to  the  payment  of  the  demand  draft  when  it  is  presented.  There- 
upon the  long  bill  either  remains  in  the  possession  of  the  bank 
that  has  purchased  it,  or  passes  from  hand  to  hand  as  it  is  redis- 
counted  by  successive  holders,  until  the  90th  day  after  its  accept- 
ance date  (93rd,  if  the  3  days  of  grace  are  added),  when  the  then 
holder  presents  it  to  the  importer  for  payment  and  receives  from 


90  FOREIGN  EXCHANGE 

him  1,000  ounces  of  gold  delivered  in  London.  With  the  retire- 
ment of  the  bill  the  financing  of  the  merchandise  shipment  is 
brought  to  a  close. 

Negotiating  a  Long  Bill  in  New  York, — Finally  comes  the 
negotiation  of  the  long  bill  in  New  York.  Of  the  several  ways  in 
which  the  exporter  can  deal  with  the  draft,  we  are  primarily 
interested  in  this  last  method,  since  it  represents  a  transaction 
in  long  exchange.  In  selling  his  bill  in  the  home  market  the  ex- 
porter combines  in  a  single  operation  the  two  steps  of  discounting 
the  bill  in  London  and  marketing  demand  exchange  against  the 
proceeds.  He  executes  a  direct  exchange  of  gold  dehverable  in 
London  90  days  after  the  bill's  acceptance  for  spot  gold  in  New 
York,  and  thus  eliminates  the  intermediate  step  of  exchanging 
London  future  gold  for  London  spot  gold,  or  the  discount  opera- 
tion in  London. 

Long  and  Demand  Exchange  Rates. — The  rate  at  which 
long  bills  sell  in  New  York,  or  the  amount  of  spot  gold  that  can 
be  procured  in  New  York  for  every  480  grains  that  will  be  deliv- 
ered in  London  in  payment  of  them  when  due,  will  now  be  dis- 
cussed. Long  exchange  tends  to  parity  with  demand  exchange, 
and  we  shall  first  examine  the  relationship  of  their  rates  when 
they  are  thus  mutually  equivalent. 

Assume  the  same  conditions  as  in  the  preceding  example, 
namely,  481  grains  for  demand  exchange,  3%  per  annum  for  the 
London  discount  rate  ''to  arrive"  for  90-day  sight  bills,  and  \% 
for  the  British  stamp  tax.  Suppose  a  person  in  New  York  has  a 
debt  to  pay  in  London,  due  on  the  day  on  which  the  next  mail 
will  arrive  from  New  York,  10  days  hence.  If  he  remits  by  pur- 
chasing demand  exchange,  he  will  have  480  grains  of  gold  in 
London  for  the  discharge  of  his  debt  against  every  481  grains  he 
pays  out  now  in  New  York.  But  he  may  also  make  the  remit- 
tance by  buying  a  90-day  sight  bill  and  sending  it  to  London  for 


LONG  EXCHANGE  9^ 

immediate  discount.  The  net  sum  which  he  will  realize,  after 
paying  for  the  bill  stamp,  will  amount  to  iVo"  ^^  ^^^  f^^^  amoimt, 
or  480  grains  on  every  (V/-  X  480)  grains  of  the  face  amount. 
If  he  should  pay  for  the  bill  a  rate  of  481  grains  for  every  ( Vg^-  X 
480)  grains  of  the  face  amount,  it  will  cost  him  precisely  as  much 
to  remit  by  this  means  as  by  the  purchase  of  demand  exchange, 
since,  as  in  the  latter  case,  he  will  also  come  into  possession  of 
480  grains  in  London  10  days  hence  for  every  481  grains  he  parts 
with  now  in  New  York.  But  this  rate,  quoted  on  the  regular 
basis  of  the  amount  of  New  York  spot  gold  the  bill  commands 
per  480  grains  of  its  face  amount,  is  (yVo  X  481)  grains 

i«AX48i  481 

i.e.. 


480         ^V-  X  480 

Thus  the  price  of  the  long  bill  is  equal  to  the  demand  price  of  481 
grains  discounted  for  the  90  days  the  bill  runs  after  its  acceptance 
at  a  rate  which  is  equal  to  the  sum  of  the  London  discount  rate 
"to  arrive'*  of  3%  per  annum  and  the  British  bill  stamp  rate  of 
1%  per  annum.  ^ 

Parity  of  Long  and  Demand  Exchange. — Long  exchange  is, 
therefore,  at  parity  with  demand  exchange  when  its  price  is 
equal  to  the  demand  price  discounted  for  the  period  it  runs  after 
sight  at  a  rate  equal  to  the  London  discount  rate  "  to  arrive" 
plus  the  British  bill  stamp  rate.  When  this  parity  relation  ob- 
tains, the  drawer  of  a  long  bill  secures  precisely  the  same  amount 
of  New  York  funds  whether  he  sells  it  in  New  York  or  in  Lon- 
don, so  that  the  two  methods  of  disposing  of  the  bill  are  mutually 
equivalent. 

The  price  of  long  exchange  constantly  gravitates  toward  par- 


'  It  will  be  observed  that  the  seller  of  the  long  bill  bears  the  cost  of  the  bill 
stamp,  for  while  the  buyer  pays  for  it  when  he  remits  the  bill  to  London,  he 
shifts  the  charge  to  the  seller  by  allowing  him  a  correspondingly  lower  price. 


92  FOREIGN  EXCHANGE 

ity  with  the  current  rate  for  demand  exchange,  as  any  divergence 
from  the  parity  position  automatically  sets  in  motion  a  process  of 
readjustment  which  tends  to  re-establish  the  equilibrium.  To 
take  again  the  example  of  the  90-day  sight  bill  and  the  same 
parity  rate  for  it  of  dVV  X  481)  grains,  suppose  that  in  conse- 
quence of  a  sudden,  heavy  outpouring  of  long  bills  upon  the 
market,  the  price  of  the  bill  is  depressed  to  a  discount  below  this 
parity  rate,  let  us  say  to  (|^|-J  X  481)  grains.  Long  exchange  is 
now  cheaper  than  demand  exchange  by  (^Jnr  X  481)  grains  for 
every  (/^V  X  480)  grains  remitted  by  mail.  The  difference  in  the 
costs  will  accordingly  prompt  remitters  to  purchase  long  exchange 
in  lieu  of  demand  drafts,  and  encourage  exporters  and  other 
makers  of  long  bills  to  negotiate  them  in  London  rather  than  in 
New  York.  Arbitrageurs  also  will  be  quick  to  seize  the  oppor- 
tunity for  a  profit  offered  by  the  disturbed  relation  of  the  rates. 
Selling  demand  bills  in  New  York,  they  will  utilize  the  proceeds 
(all  but  a  small  balance,  which  will  represent  their  profit)  for  the 
purchase  of  an  amount  of  long  bills  which,  when  discounted  in 
London,  will  provide  sufficient  cover  for  the  demand  drafts. 
Their  gain  on  the  transaction  will  amount  to  (^f^  X  481)  grains 
for  every  dVir  X  480)  grains  of  demand  exchange  they  will 
sell  against  the  simultaneous  purchase  of  480  grains  of  long 
exchange. 

The  existence  of  the  disparity  between  the  two  rates,  then, 
results  in  a  quickening  of  the  demand  and  a  curtailment  of  the 
supply  of  long  exchange,  and  in  a  falling  off  in  the  demand  and  an 
increase  in  the  supply  of  demand  exchange.  The  rate  for  long 
exchange  is,  therefore,  forced  up,  and  that  for  demand  exchange 
is  driven  down.  As  the  quotations  thus  draw  closer  together, 
they  approach  a  position  of  mutual  parity.  The  balance  is  re- 
stored all  the  more  quickly  because  of  the  upward  tendency  im- 
parted to  the  London  discount  rate  by  the  heavier  offerings  of 
long  bills  attracted  to  that  city,  as  the  advancing  discount  rate 
widens  the  parity  margin  between  the  exchange  quotations. 


LONG  EXCHANGE  93 

Long  Exchange  at  a  Premiiun. — Turning  now  to  the  reverse 
instance  of  disparity,  in  which  the  rate  for  long  exchange  is  at  a 
premium  above  its  parity  with  demand  exchange,  let  us  suppose 
that  the  prevailing  rate  for  90-day  sight  bills  is  (^|  X  481)  grains, 
while  its  parity  rate  is,  as  before,  (y%\  X  481)  grains.  Long  ex- 
change is  now  dearer  than  demand  exchange  by  (^wo  X  481) 
grains  on  a  mail  remittance  of  (f^V  X  480)  grains.  Drawers  of 
90-day  bills  will,  therefore,  sell  the  drafts  in  New  York  rather 
than  in  London,  while  remitters  will  purchase  demand  exchange 
rather  than  long  bills.  Besides,  arbitrageurs  will  sell  in  New 
York  90-day  bills  drawn  on  London  banks  that  have  agreed  to 
lend  them  their  credit  by  accepting  the  bills  (see  page  95),  and 
at  the  same  time,  by  way  of  providing  cover  for  these  drafts,  they 
will  purchase  demand  exchange  and  arrange  to  lend  the  London 
gold  they  will  thus  procure  for  the  90  days  the  long  bills  run 
after  sight.  Their  profit  will  amount  to  dr-J-g-  X  481)  grains  for 
every  480  grains,  face  amount,  of  90-day  bills  they  sell  against 
the  concurrent  purchase  of  (y%%-  X  480)  grains  of  demand 
exchange. 

Thus  when  the  price  for  90-day  sight  bills  is  above  its  parity 
with  demand  exchange,  the  demand  for  the  drafts  declines  and 
the  supply  increases,  bringing  down  their  market  price.  Con- 
currently, the  demand  for  demand  exchange  expands  and  the 
supply  diminishes,  forcing  up  its  rate.  The  two  rates,  therefore, 
draw  farther  away  from  each  other,  and  in  doing  so  they  tend  to 
accommodate  themselves  to  a  parity  basis.  The  readjustment  is 
accelerated  by  the  decline  which  the  London  discount  rate  under- 
goes as  a  result  of  the  lessened  volume  of  long-bill  offerings  in  that 
city,  since  a  reduction  in  the  interest  rate  signifies  a  contraction 
in  the  parity  spread  between  the  two  exchange  prices. 

Tending  thus  to  maintain  a  definite  relation  to  the  demand 
rate,  the  price  for  long  exchange  necessarily  moves  up  and  down 
with  the  demand  price  as  the  latter  responds  to  the  changing 
conditions  of  supply  and  demand.    But  at  the  same  time  the 


94  FOREIGN  EXCHANGE 

\  distance  it  maintains  from  the  demand  price  increases  and  con- 
tracts as  the  London  rate  of  discount  advances  and  decHnes. 


Investment  Buying  of  Long  Bills. — One  particular  source  of 
demand  for  long  bills  merits  special  attention.  It  comprises  pur- 
chases by  those  who  intend  holding  the  bills  till  maturity  as  tem- 
porary investments,  particularly  when  the  bills  can  be  bought  at 
prices  which  promise  a  higher  rate  of  return  than  can  be  secured 
on  loans  of  similar  length  in  New  York.  One  object  of  making 
such  investments  is  to  anticipate  the  payment  of  a  debt  owed  in 
London  and  at  the  same  time  to  avoid  the  risk  of  a  future  advance 
in  the  exchange  rate.  An  American  importer,  for  example,  who 
has  engaged  to  pay  an  English  merchant  in  London  on  a  certain 
future  date,  may  to  all  intents  and  purposes  settle  his  account  in 
advance  by  buying  and  retaining  a  long  bill  maturing  approxi- 
mately when  his  own  debt  comes  due.  As  the  payment  date 
draws  near,  he  has  merely  to  remit  the  long  bill  to  his  creditor  in 
satisfaction  of  his  obligation. 

When  long  exchange  is  purchased  for  investment  purposes, 
but  not  to  anticipate  a  debt  in  London,  the  buyer  will  sell  demand 
^exchange  (or  cables)  when  the  bill  draws  near  maturity,  by  way  of 
transferring  his  funds  back  to  New  York.  The  rate  of  return  on 
his  investment  will  manifestly  depend  upon  the  price  he  will  get 
for  his  demand  exchange,  as  compared  with  the  price  he  pays  for 
the  long  bill.  To  take  a  concrete  case,  suppose  he  purchases  a 
90-day  sight  bill  at  the  rate  of  (|4  X  481)  grains.  If  towards  the 
maturity  of  the  bill  he  should  sell  demand  exchange  at  the  rate 
of  481  grains,  the  investment  will  have  netted  him  a  return  of 
(A  X  481)  grains  on  every  (|-|-  X  481)  grains  of  his  outlay,  or 
slightly  over  5%  per  annum,  assuming  that  just  exactly  a  quarter 
of  a  year  elapses  between  his  purchase  of  the  long  bill  and  the  sale 
of  his  demand  exchange.  If  he  wishes  to  eliminate  all  uncertainty 
with  regard  to  the  rate  of  his  income,  he  may  sell  at  the  outset 
future  demand  exchange  (or  future  cables)  for  dehvery  10  days 


I 
LONG  EXCHANGE  95 

or  SO  prior  to  the  maturity  of  the  long  bill.  The  )deld  on  his  in- 
vestment will  in  that  case  be  fixed  by  the  relation  of  the  price  at 
which  he  sells  the  future  to  the  price  he  pays  for  the  long  bill.  But 
if  future  demand  and  long  exchange  are  at  parity  with  spot 
demand  exchange,  and,  therefore,  at  parity  with  each  other,  his 
return  will  be  exactly  equal  to  the  rate  of  interest  on  loans  in 
New  York. 

Long  Bills  as  Instruments  of  Short-Time  Borrowing.— By  far 

the  greater  proportion  of  long  bills  comes  upon  the  market  from 
the  hands  of  exporters  in  the  manner  already  indicated.  But 
there  is  another  quite  different  source  of  supply,  which  on  occa- 
sion is  responsible  for  no  small  volume  of  long  bills.  It  comprises 
sales  by  those  who  draw  the  bills  for  the  purpose  of  raising, 
directly  or  indirectly,  short-time  loans  in  the  open  discount  mar- 
ket in  London. 

The  simplest  way  in  which  an  American  borrower  can  contract 
a  short-dated  loan  in  the  British  center  is,  of  course,  to  discount 
his  plain  promissory  note.  But  his  single-name  paper,  no  matter 
how  highly  it  may  be  rated  in  the  New  York  market,  can  only  be 
negotiated  in  London  privately,  with  the  particular  institution 
with  which  he  maintains  a  regular  banking  connection.  If  he 
wants  to  borrow  in  the  open  London  market,  he  can  do  so  only 
on  a  prime  British  name,  which  invariably  is  that  of  first-class 
bank  or  banking  house.  To  secure  the  use  of  such  a  name  he 
enters  into  an  arrangement  with  his  London  bank,  whereby  he  is 
permitted  to  draw  a  bill  of  exchange  upon  it  for  the  amount  and 
period  agreed  upon.  By  accepting  the  draft  the  bank  engages  to 
pay  it  at  maturity.  But  it  has  in  turn  the  American  borrower's 
guarantee,  secured  by  collateral  or  not,  according  to  his  financial 
standing,  to  provide  it  with  funds  for  the  amount  of  the  bill  a 
day  or  two  before  it  falls  due.  For  lending  its  name  in  this  man- 
ner the  London  bank  charges  a  commission,  which  varies  with  the 
borrower's  financial  responsibiUty  and  the  currency  of  the  bill, 


96  FOREIGN  EXCHANGE 

and  which  approximately  represents  the  difference  between  the 
rates  at  which  he  can  borrow  on  his  own  and  the  bank's  name- 
On  6o-and  90-day  sight  bills  the  charge  is  generally  i  or  ^%  of  the 
face  amount. 

Provided  thus  with  an  instrument,  which  when  accepted  will 
represent  the  direct  obhgation  of  a  prime  London  bank,  the  Amer- 
ican borrower  can  now  proceed  to  contract  his  London  loan.  As 
in  the  case  of  bills  issued  by  exporters,  he  has  the  choice  of  either 
forwarding  his  draft  to  London  for  acceptance  and  immediate 
discount,  and  simultaneously  selling  demand  exchange  against  the 
prospective  proceeds;  or  of  selHng  it  in  New  York  on  the  strength 
of  his  own  name  and  leaving  it  to  the  buyer  to  procure  its  accept- 
ance in  London.  The  total  cost  of  the  loan  to  him  will  include  the 
interest  discount,  the  British  bill  stamp,  and  the  acceptance  com- 
mission. It  should  be  noted,  however,  that  when  he  sells  the 
bill  in  New  York  he  makes  allowance  in  its  price  only  for  the 
first  two  items,  as  he  pays  the  acceptance  commission  himself, 
remitting  it  usually  when  he  reimburses  the  accepting  bank  on 
the  bUl. 

Reasons  for  Issuing  Long  Bills. — One  of  the  purposes  for 
which  an  American  borrower  may  desire  to  issue  a  long  bill  on 
London  is  to  anticipate  the  payment  of  money  that  is  due  him  in 
that  city  at  about  the  time  the  bill  matures,  particularly  if  he 
does  not  care  to  run  the  risk  of  a  future  decline  in  the  exchange 
rate.  In  a  case  of  this  sort  he  will  be  able  to  furnish  the  London 
accepting  bank  with  cover  for  the  bill  without  the  necessity  of 
remitting  exchange.  Frequently,  however,  he  has  not  in  prospect 
any  receipt  of  money  in  London,  and  his  only  object  in  putting 
out  the  bill  is  to  avail  himself  of  a  cheaper  interest  rate.  Under 
those  circumstances  he  will  be  able  to  put  the  acceptor  in  funds 
only  by  purchasing  demand  exchange  (or  cables)  toward  the  expiry 
of  the  long  bill.  It  is,  therefore,  apparent  that  when  he  sells  the 
bill  in  New  York,  the  total  charge  he  incurs  on  the  loan  will 


LONG  EXCHANGE  97 

amount  to  the  difference  between  the  cost  of  the  demand  ex- 
change he  will  remit  to  pay  the  maturing  bill  and  acceptance 
commission,  and  the  proceeds  of  the  long  bill. 

To  illustrate,  suppose  he  sells  a  90-day  sight  bill  in  New  York 
at  the  rate  of  (yW  X  481)  grains,  and  90  days  later,  when  he  re- 
mits cover  and  the  acceptance  commission  of  ^%,  he  buys  demand 
exchange  at  the  rate  of  481  grains.  For  the  (iVo"  X  481)  grains 
he  realized  on  every  480  grains  of  the  face  amount  of  the  long  bill, 
he  now  expends  (^^  X  481)  grains  in  making  the  remittance, 
including  (^^  X  481)  grains  for  the  acceptance  commission.  In 
terms  of  New  York  funds,  therefore,  the  90-day  loan  has  cost  him 
(-gV  X  481)  grains  for  every  (^V  X  481)  grains  the  bill  netted 
him  in  New  York,  or  slightly  over  5%  per  annum. 

To  reduce  the  risk  of  a  possible  big  advance  in  the  price  of  de- 
mand exchange  pending  the  maturity  of  the  long  bill,  which  would 
increase  the  cost  of  the  loan,  unduly,  American  borrowers  in 
London,  if  they  permit  themselves  to  incur  any  risk  at  all,  cus- 
tomarily issue  their  long  bills  in  the  late  spring  of  the  year,  when 
exchange  rates  are  normally  high  because  of  comparatively  heavy 
imports  and  give  every  promise  of  undergoing  the  usual  seasonal 
decline  with  the  approach  of  the  autumn  months,  when  the  grain 
and  cotton  export  movement  gets  under  way.  But  if  they  are 
desirous  of  avoiding  the  risk  entirely  and  fixing  at  the  outset  the 
cost  of  their  borrowing  in  terms  of  New  York  gold,  they  have  re- 
course to  the  purchase  of  future  exchange  at  the  time  they  issue 
the  long  bills,  for  delivery  when  the  bills  mature. 

Frequently  it  is  agreed  in  the  original  contract  that  the  Amer- 
ican borrower  shall  have  the  privilege  of  renewing  the  loan  a  cer- 
tain number  of  times  at  his  option.  The  renewal  is  effected  on 
each  occasion  by  the  borrower  drawing  on  the  London  drawee 
another  bill  for  the  same  period  as  the  preceding  one  but  for  a 
slightly  larger  amount,  so  that  when  sold  in  New  York  it  yields 
a  sum  sufficient  to  meet  the  cost  of  the  remittance  made  against 
the  maturing  bill. 


98  FOREIGN  EXCHANGE 

Long  Bills  Quoted  According  to  Their  Security, — Long  bills 
of  the  same  maturity  do  not  sell  in  New  York  for  a  uniform  price 
but  at  rates  which  vary  with  the  relative  degree  of  security  they 
represent  in  the  judgment  of  the  purchasers.  Their  comparative 
soundness  as  investments  depends  upon  three  elements,  namely: 

1.  The  financial  responsibility  of  the  American  drawers  and 

any  subsequent  indorsers. 

2.  The  financial  responsibility  of  the  foreign  acceptors. 

3.  The  nature  of  the  collateral  security,  if  any,  underl3dng 

them. 

Inasmuch  as  the  bills  represent  virtually  the  sole  liability  of  the 
drawers  until  they  are  accepted  on  the  other  side,  those  made  out 
by  drawers  of  superior  credit  command,  all  other  things  being 
equal,  higher  prices  in  New  York.  Upon  being  accepted  in  Lon- 
don, they  are  graded  and  discounted  there  on  the  basis  of  the 
relative  standing  of  their  acceptors.  Hence  their  price  in  New 
York  is  also  affected  by  the  acceptors'  financial  responsibility. 
Bills  drawn  and  accepted  by  banks  of  the  highest  standing  and 
reputation  enjoy  the  highest  rate  and  are  commonly  described  as 
"prime  bills." 

The  financial  ratings  of  the  drawer  and  acceptor  are  the  prin- 
^cipal  factors  determining  the  relative  security  of  a  long  bill.  If 
one  or  the  other,  or  both,  are  not  of  the  best  credit,  the  quality  of 
the  bill  may  be  improved  by  placing  collateral  security  behind  it. 
Bills  issued  by  exporters  against  their  merchandise  consignments 
commonly  have  for  their  collateral  accompanying  bills  of  lading, 
giving  holders  a  lien  on  the  underlying  shipments.  The  measure 
of  security  afforded  by  the  ladings  depends  upon  the  character  of 
the  goods  composing  the  shipment,  whether  perishable  or  non- 
perishable,  and  whether  staple  and  readily  salable,  or  having  a 
limited  market.  The  condition  on  which  the  holder  of  the  draft 
surrenders  the  lading  to  the  drawee  is  arranged  at  the  outset  be- 


LONG  EXCHANGE  99 

tween  drawer  and  drawee,  and  the  bill  is  subsequently  negotiated 
on  that  basis.  If  the  drawee's  credit  is  of  the  highest,  the  docu- 
ment may  be  released  to  him  upon  his  accepting  the  draft. 
Otherwise  he  is  obliged  to  wait  for  it  until  he  has  paid  the  draft, 
but  not  necessarily  until  the  draft  matures,  as  he  may  be  accorded 
the  privilege  of  paying  the  draft  in  advance.  The  collateral  bcr 
hind  long  bills  put  out  by  borrowers  usually  consists  of  purchased 
drafts,  warehouse  receipts,  stocks,  and  bonds. 

Formula  for  Parity  Rate  of  Long  Bills, — In  deriving  the  form- 
ula for  the  parity  rate  of  long  bills  it  was  tacitly  assumed  that  they 
were  all  of  the  same  grade  in  point  of  security,  and  that,  therefore, 
bills  of  the  same  maturity  sold  for  one  and  the  same  price.  It  was 
further  assumed  that  demand  drafts  sold  by  the  drawers  of  the 
long  bills  were  also  quoted  at  a  uniform  price.  As  the  contrary 
is  true  in  respect  to  both  of  these  suppositions,  it  is  necessary  in 
the  interest  of  greater  accuracy  to  restate  the  formula  as  follows: 
The  parity  rate  of  any  given  grade  of  long  bills  is  equal  to  the 
price  at  which  their  drawers  can  market  demand  drafts,  dis- 
counted for  the  number  of  days  the  long  bills  run  after  sight  at  a 
rate  that  is  equal  to  the  sum  of  the  rate  *'  to  arrive"  at  which  the 
bills  are  discountable  in  London  and  the  British  bill  stamp  rate. 

Quoting  Long  Bills  in  Terms  of  Foreign  Gold, — The  manner 
of  computing  the  parity  price  of  a  long  bill  on  London  when  the 
rates  of  exchange  are  denoted  by  the  second  system  of  quotation, 
or  in  terms  of  London  gold,  must  now  be  briefly  considered. 
Under  the  first  system,  when  demand  exchange  is  481  grains,  and 
the  discount  and  bill  stamp  rates  are  together  equal  to  4%  per 
annum,  the  parity  price  of  90-day  sight  bills  is  (  jVV  X  481)  grains 
of  New  York  gold.     But  as  this  ratio  of 

(rW  X  481)  grains  of  New  York  gold 
480  grains  of  London  gold 


100  FOREIGN  EXCHANGE 

is  equal  to  the  ratio 

480  grains  of  New  York  gold 


(w  X  479TiT)  grains  of  London  gold 

it  is  evident  that  the  parity  price  of  the  90-day  sight  bill  is  ('^  X 
479:f ^j)  grains  when  expressed  in  terms  of  London  gold.  More- 
over, since  479TiT  grains  is  the  demand  price  given  in  terms  of 
London  gold, 

481         480 


I.e. 


480      479t¥t 


it  follows  that  under  the  second  system  of  quoting  exchange  rates 
the  parity  price  of  a  long  bill  is  equal  to  the  demand  price  plus 
^ ,  interest  on  it  for  the  period  the  bill  runs  after  sight,  calculated  at  a 
rate  equal  to  the  sum  of  the  London  discount  rate  ^'  to  arrive'*  and 
the  British  bill  stamp  rate. 

Long  Bills  Issued  in  London  upon  New  York. — Long  bills  are, 
of  course,  also  issued  in  London  upon  New  York,  and  are  traded 
in  there  in  precisely  the  manner  in  which  long  bills  on  London  are 
dealt  in  here.  The  parity  price  of  a  long  bill  in  London  is  natur- 
ally governed  by  the  price  quoted  for  demand  exchange  on  New 
York  and  the  New  York  rate  of  discount.  As  the  prices  for  New 
York  exchange  are  indicated  in  London  in  terms  of  New  York  gold 
or  by  the  second  method  of  quotation,  the  parity  prices  for  long 
bills  in  London  are  determined  in  accordance  with  the  formula 
laid  down  in  the  preceding  section  with  reference  to  parity  prices 
of  long  bills  in  New  York  on  London  when  quoted  in  terms  of 
London  gold. 


CHAPTER  VII 

TRIANGULAR  EXCHANGE 

Transactions  between  Two  Cities  Settled  by  Payment  in  a 
Third, — Having  completed  the  analysis  of  the  principles  of  gold 
exchanging  as  carried  on  between  two  cities,  we  have  yet  to  deal 
in  this  theoretical  part  of  our  treatise  with  the  manner  in  which 
the  rates  for  the  exchanges  between  three  or  more  markets  are 
related  to  one  another.  These  rates  tend  constantly  to  mutual 
dependence,  so  that  a  movement  in  one  cannot  take  place  without 
more  or  less  affecting  the  others.  In  ascertaining  the  precise 
nature  and  cause  of  this  interdependence,  we  shall  take  the  simple 
case  of  the  following  three  cities — New  York,  London,  and  Paris. 
An  examination  of  this  triangular  or  three-cornered  exchange,  as 
it  is  usually  called,  will  reveal  the  general  principles  underlying 
the  relationship  which  the  rates  for  the  exchanges  between  all  the 
markets  of  the  world  tend  to  keep  with  one  another. 

A  Triangular  Example. — Between  each  two  of  the  above- 
named  three  cities  settlements  are  continually  being  made  which 
call  for  the  delivery  of  gold  in  the  one  or  the  other.  Dealings 
accordingly  take  place  in  each  of  these  centers  in  exchange  on  the 
other  two,  in  the  form  of  cable  transfers,  demand  and  long  drafts, 
both  for  spot  and  future  delivery,  precisely  as  has  been  explained 
with  reference  to  exchange  between  New  York  and  London.  Not 
only,  then,  is  trading  conducted  in  New  York  in  exchange  on 
London  and  in  London  in  exchange  on  New  York;  but  in  New 
York,  exchange  is  dealt  in  on  Paris,  and  in  Paris  on  New  York, 
and  in  London,  exchange  is  traded  in  on  Paris,  and  in  Paris  on 
London. 

Not  all  the  settlements  between  New  York  and  Paris,  however, 

lOI 


) 


102  FOREIGN  EXCHANGE 

are  made  in  either  of  these  centers.  To  a  certain  extent  they  are 
effected  by  the  delivery  of  gold  in  London.  Adams  in  New 
York,  for  example,  may  owe  Binet  in  Paris  a  debt  that  he  has  con- 
tracted to  pay  in  London.  By  way  of  retiring  it  he  purchases 
any  one  of  the  several  classes  of  exchange  on  London.  If  he 
buys  a  spot  cable  transfer  he  instructs  the  seller  of  it  to  cable  the 
custodian  of  his  gold  in  London  to  place  the  stipulated  amount  at 
the  disposal  of  Binet,  who  is  advised  at  the  same  time  that  the 
gold  is  held  for  his  account.  Thereupon  the  latter  transfers  these 
funds  to  Paris  by  selling  a  cable  transfer,  demand  or  long  drafts 
on  London,  as  suits  his  convenience. 

Should  Adams  purchase,  instead,  demand  exchange  on  Lon- 
don, he  remits  the  draft  to  Binet  by  the  first  departing  mail. 
Upon  receiving  the  bill  Binet  disposes  of  it  at  once  in  the  Paris 
market,  or  sends  it  immediately  to  London  for  collection  and  sells 
his  own  demand  or  cable  exchange  against  the  proceeds.  Assum- 
ing that  Adams  was  able  to  give  the  seller  of  the  draft  satisfactory 
assurances  that  it  would  travel  to  London  by  way  of  Paris  and  not 
directly,  he  was  charged  a  lower  rate  for  it  than  the  prevailing 
quotation  for  demand  drafts  forwarded  directly  to  London,  be- 
cause of  its  later  arrival  in  London  and  the  consequent  later 
delivery  of  the  London  gold. 

Finally,  if  Binet  agrees  to  accept  payment  by  drawing  a  long 
bill  on  Adams  made  payable  in  London,  he  sells  the  draft  in  Paris, 
either  immediately  or  at  any  time  during  its  life;  or  he  holds  it  to 
maturity  and  then  sells  either  demand  or  cable  exchange  against 
its  collection.  As  its  due  date  draws  near,  Adams  purchases  a 
demand  draft  or  a  cable  transfer  on  London,  if  he  has  not  already 
provided  himself  with  the  necessary  cover  by  buying  either  of 
these  forms  of  remittance  for  future  delivery.  Whatever  the 
form  in  which  Binet  accepts  payment,  he  will  compute  his  receipts 
in  every  case  in  the  amount  of  home  or  Paris  gold  the  sale  of  the 
London  exchange  nets  him  now  or  in  the  future. 

Exchange  on  London  thus  serves  as  a  medium  of  payment  be- 


TRIANGULAR  EXCHANGE  103 

tween  the  American  and  the  French  metropolis.  Indeed,  London 
is  chosen  for  the  point  of  delivery  in  the  settlement  of  a  consider- 
able proportion  of  international  transactions  in  every  quarter  of 
the  globe.  The  fact  is  alluded  to  in  the  common  observation  that 
London  is  the  world's  financial  clearing-house,  or  money  center. 
For  that  reason,  gold  exchanging  with  London  is  carried  on  in 
most  parts  of  the  world  on  a  much  greater  scale  than  with  any 
other  center,  so  that  London  exchange  is  the  premier  remittance 
in  the  great  majority  of  the  foreign  exchange  markets  of  the 
world. 

Tendency  of  Exchange  Rates  to  Triangular  Parity. — The 

most  important  fact  in  connection  with  gold  exchanges  between 
three  cities  is  that  each  tends  to  be  equivalent  to  the  other'  . 
two  taken  in  combination.  When  this  so-called  triangular  parity 
relation  obtains  between  New  York,  Paris,  and  London,  it  matters 
not  whether,  for  example.  New  York  gold  is  exchanged  directly 
for  London  gold  by  the  purchase  of  London  exchange  in  New 
York,  or  the  sale  of  New  York  exchange  in  London;  or  whether  it 
is  first  exchanged  for  Paris  gold  by  the  purchase  of  Paris  exchange 
in  New  York,  or  the  sale  of  New  York  exchange  in  Paris,  and  the 
Paris  gold  is  in  turn  exchanged  for  London  gold  by  the  purchase 
of  London  exchange  in  Paris,  or  the  sale  of  Paris  exchange  in  Lon- 
don. The  same  amount  of  London  gold  is  realized  against  the 
surrender  of  a  given  amount  in  New  York  in  either  case. 

Let  us  assume  a  case  of  triangular  parity  between  the  spot  > 
cable  rates  for  the  three  exchanges,  the  form  of  remittance  in- 
variably  employed  in  three-cornered  operations.  Suppose  the 
rate  in  New  York  for  cables  on  London  is  482  grains  (of  New  York 
gold  against  480  grains  of  London  gold),  and  the  rate  in  Paris  for 
cables  on  London  is  481  grains  (of  Paris  gold  against  480  grains  of 
London  gold).  If  at  the  same  time  the  price  for  Paris  cables  in 
New  York  is  such  that  482  grains  of  New  York  gold  will  exchange 
for  481  grains  of  Paris  gold,  remittance  to  London  by  means  of  the 


104  FOREIGN  EXCHANGE 

two  consecutive  exchanges — the  purchase  of  Paris  cables  in  New 
York  and  of  London  cables  in  Paris — will  cost  a  remitter  precisely 
as  much  as  the  single  direct  exchange  of  buying  London  cables 
in  New  York.  As  usually  quoted,  this  rate  for  Paris  cables  is 
48off  y  grains,  since  the  ratio  of  482  grains  of  New  York  gold  to 
481  grains  of  Paris  gold  corresponds  to  the  ratio  of  48o||t  grains 
of  New  York  gold  to  480  grains  of  Paris  gold. 

Naturally,  with  the  rates  for  the  three  exchanges  standing  in 
this  relation  to  each  other,  the  reverse  is  also  true :  that  a  person 
who  desires  to  exchange  London  gold  for  New  York  gold  fares  the 
same  whether  he  sells  London  cables  in  New  York,  or  takes  the 
roundabout  course  of  selling  in  turn  London  cables  in  Paris  and 
Paris  cables  in  New  York.  When  the  three  rates  are  thus  in 
equilibrium,  Paris  cables  are  said  to  be  ''at  parity"  with  London 
cables  in  New  York  and  in  Paris,  and  their  rate  is  referred  to  as 
the  "parity"  of  the  rates  for  the  two  London  exchanges. 

Parity  Disturbed. — When  this  triangular  equilibrium  is  dis- 
turbed by  a  change  in  one,  two,  or  all  three  of  the  rates,  the  read- 
\  justment  that  immediately  follows  in  the  demand  and  supply  of 
the  three  exchanges  operates  to  restore  the  balance.  To  illus- 
trate, suppose  that  when  the  rates  for  London  cables  in  New  York 
and  in  Paris  are  respectively  482  and  481  grains,  the  rate  for  Paris 
cables  in  New  York  is  480 J  grains,  or  f  Jf  of  a  grain  below  the 
triangular  parity  of  48o||y  grains.  In  that  case  it  costs  fjf  of  a 
grain  more  of  New  York  gold  to  remit  4  79^  ft  grains  to  London  by 
purchasing  London  cables  in  New  York  than  by  purchasing  first 
Paris  cables  in  New  York  and  then  London  cables  in  Paris,  since 
the  price  of  479tft  grains  of  London  cables  in  New  York  is  48oilT 
grains,  whereas  only  480^  grains  are  required  to  buy  480  grains  of 
Paris  cables  in  New  York,  which  in  turn  will  purchase  479Trr 
grains  of  London  cables  in  Paris. 

The  natural  consequence  of  this  rate  situation  is,  in  the  first 
place,  that  remitters  of  funds  from  New  York  to  London— those 


TRIANGULAR  EXCHANGE  105 

of  them  that  are  in  a  position  to  do  so — will  resort  to  the  two  con- 
secutive exchanges  by  way  of  Paris,  in  preference  to  the  single 
direct  exchange.  On  the  other  hand,  since  the  conversion  of 
4794  K  grains  of  London  gold  into  New  York  gold  will  bring  |J|  of 
a  grain  more  of  the  latter  if  the  exchange  is  accomplished  by  the 
sale  of  London  cables  in  New  York  than  if  made  by  the  sale  of 
London  cables  in  Paris  and  Paris  cables  in  New  York,  persons 
making  such  conversions  will  be  prompted  to  use  the  former 
method.  Finally,  the  disparity  of  the  three  rates  will  induce 
arbitrageurs  to  purchase  Paris  cables  in  New  York  and  London 
cables  in  Paris,  and  then  sell  London  cables  in  New  York.  The 
third  exchange  will  offset  the  first  two,  and  leave  the  arbitra- 
geurs a  profit  of  IJf  of  a  grain  of  New  York  gold  for  every  479  jir 
grains  of  London  cables  they  buy  in  Paris  and  sell  in  New  York. 

Thus,  when  Paris  cables  in  New  York  are  quoted  below  parity 
in  relation  to  the  other  two  exchanges,  the  demand  for  Paris  cables 
in  New  York  and  for  London  cables  in  Paris  tends  to  rise  and  the 
supply  to  decline.  Their  rates,  therefore,  must  needs  make  for 
higher  levels.  At  the  same  time  the  demand  for  London  ex- 
change in  New  York  tends  to  diminish  and  the  supply  to  increase, 
so  that  its  rate  is  driven  down.  In  the  process  of  readjustment, 
the  Paris  cable  parity  rate  in  New  York  declines  and  meets  the 
rising  market  quotation  for  the  same  remittance,  thus  re-estab- 
lishing the  triangular  balance. 

The  same  tendency  to  triangular  parity  manifests  itself  in  the 
opposite  case  of  disparity.  Assume  that  when  London  cables  are 
482  grains  in  New  York  and  481  grains  in  Paris,  the  rate  for  Paris 
cables  in  New  York  is  48  ig-  grains,  or  |^|  of  a  grain  above  the 
parity  rate  of  48o|fY  grains.  It  now  advantages  those  who  are 
converting  London  gold  into  New  York  gold  to  make  the  double 
sale  of  exchange,  first  in  Paris  on  London  and  then  in  New  York 
on  Paris,  for  by  so  doing  they  realize  481^  grains  of  New  York  gold 
against  every  479^^1  grains  they  part  with  in  London,  which  com- 
pares with  only  480^ ff  grains  if  they  make  the  conversion  by  the 


I06  FOREIGN  EXCHANGE 

sale  of  London  cables  in  New  York.  On  the  other  hand,  it  is 
more  economical  in  the  same  situation  of  the  rates  for  those  re- 
mitting from  New  York  to  London  to  purchase  London  cables  in 
New  York  than  to  remit  by  way  of  Paris,  since  they  thereby  effect 
a  saving  of  ||  f  of  a  grain  for  every  479^|t  grains  remitted.  Then, 
too,  the  disparity  of  the  rates  leads  to  arbitraging,  which  in  this 
case  consists  of  the  purchase  of  London  cables  in  New  York  and 
the  sale  of  London  cables  in  Paris  and  of  Paris  cables  in  New  York, 
the  profit  on  the  operation  being  |-||  of  a  grain  of  New  York  gold 
for  every  479^ir  grains  of  London  cables  purchased  in  New  York 
and  sold  in  Paris. 

Consequently,  when  the  price  of  Paris  cables  in  New  York 
rules  above  parity  in  relation  to  the  prices  for  London  cables  in 
/  New  York  and  in  Paris,  the  buying  of  London  cables  in  New  York 
increases  and  the  selling  decreases,  with  the  result  that  the  rate 
advances.  On  the  other  hand,  the  buying  of  Paris  cables  in  New 
York  and  of  London  cables  in  Paris  falls  off  and  the  selling  be- 
comes heavier,  so  that  their  prices  decline.  The  eventual  out- 
come of  these  rate  movements  is  that  the  Paris  cable  parity  rate 
in  New  York  rises  and  meets  the  declining  market  quotation  for 
the  same  remittance,  thus  bringing  the  three  rates  back  to  a  state 
of  triangular  parity. 

Tendency  to  Three-Cornered  Equilibrium. — The  rates  for  the 
three  exchanges  constantly  tend,  therefore,  to  accommodate 
themselves  to  three-cornered  equilibrium.  In  the  course  of  the 
readjusting  process  all  are  affected,  but  the  greatest  variation 
^/  necessarily  takes  place  in  the  rate  of  the  exchange  possessing  the 
narrowest  market  and,  therefore,  most  readily  responsive  to  a 
given  volume  of  buying  and  selling.  In  the  preceding  illustra- 
tion, for  example,  the  disparity  is  corrected  far  more  through  a 
fall  in  the  rate  for  Paris  cables  in  New  York,  than  by  an 
advance  in  London  cables  in  New  York  or  a  decline  in  Lon- 
don cables  in  Paris,  for,  as  we  have  noted,  the  latter  tw> 


TRIANGULAR  EXCHANGE  IO7 

exchanges  are  considerably  more  active  than  Paris   cables  in 
New  York. 

One  Rate  Determined  by  Extent  of  Deviation  between  Other 
Two. — From  what  has  been  said  above  it  is  apparent  that  when 
Paris  cables  are  in  three-cornered  parity  with  London  cables  in 
New  York  and  in  Paris,  the  following  equation  is  true: 

London  cable  rate  in  New  York       Parity  for  Paris  cables  in  New  York 
London  cable  rate  in  Paris  480  grains  of  Paris  gold 

It  follows  from  this  that  when  the  London  cable  rates  in  New 
York  and  Paris  are  equal,  the  parity  rate  for  Paris  cables  in  New 
York  is  at  par.  Furthermore,  when  the  rate  for  London  cables 
in  New  York  is  quoted  above  that  in  Paris,  the  parity  rate  for 
Paris  cables  in  New  York  is  at  a  premium.  The  amount  of  this 
premium  represents  the  same  percentage  of  par  as  the  difference 
between  the  two  London  cable  rates  represents  of  the  London 
cable  rate  in  Paris.  In  the  opposite  case,  when  the  London  cable 
rate  in  New  York  is  below  that  in  Paris,  the  parity  rate  for  Paris 
cables  in  New  York  is  at  a  discount,  the  amount  of  which  bears  the 
same  ratio  to  par  as  the  diiBference  between  the  London  cable  rates 
in  Paris  and  New  York  bears  to  the  London  cable  rate  in  Paris.' 
The  amount  of  the  premium  or  discount  on  the  rate  for  Paris 
cables  in  New  York  is  limited  to  a  maximum  of  a  little  in  excess  of 
the  cost,  including  loss  of  interest,  of  consigning  gold  from  New 
York  to  Paris,  or  from  Paris  to  New  York.  Therefore,  the  Lon- 
don cable  rates  in  New  York  and  Paris  can  diverge  from  each 
other  only  by  a  percentage  which  is  slightly  greater  than  the  per- 
centage which  the  gold  export  premium  or  import  discount  on 
Paris  cables  in  New  York  is  of  par.     If,  for  example,  the  cost  and 


When  fpur  quantities,  a,  h,  c,  and  d,  are  in  proportion,  forming  the  equa- 

a       c    .       {a  —  b)  ,    (c  —   '' 

r  =  J,  then 7 equals y 

b      a  b  a 


a       c    .       (a  —  b)          ,    (c  —  d)        ^  (b  —  a)          ^    (d  —  c) 
tion  r  =  J,  then  — r equals  — -z — »  and 7 —  equals 


I08  FOREIGN  EXCHANGE 

interest  loss  on  a  gold  shipment  from  New  York  to  Paris  amounts 
to  4  grains  or  y  ^^  of  par,  the  London  cable  rate  in  New  York  can- 
not advance  much  farther  than  |f^  of  the  London  cable  rate  in 
Paris.  Likewise,  if  the  cost  and  interest  loss  in  transporting  gold 
from  Paris  to  New  York  is  4  grains,  the  London  cable  rate  in  Paris 
can  rise  no  higher  than  slightly  over  |jj^  of  the  London  cable  rate 
in  New  York.  On  the  other  hand,  whether  gold  will  move  in 
either  direction  between  Paris  and  New  York  will  depend  on  the 
relative  position  of  the  two  London  cable  rates,  which  governs  the 
size  of  the  premium  or  discount  on  the  rate  for  Paris  cables  in 
New  York. 

In  arbitraging  against  a  shipment  of  gold,  let  us  say,  from  New 
York  to  London,  the  shipper  may  effect  his  offsetting  sale  of  ex- 
change by  marketing  London  cables  in  Paris  and  Paris  cables  in 
New  York,  in  lieu  of  selling  London  exchange  in  New  York.  He 
has  recourse,  however,  to  such  consecutive  selHng  by  way  of  the 
French  center  only  in  the  event  that  the  rate  for  London  cables  in 
New  York,  even  though  ruling  above  its  export  point,  is  still  be- 
low its  triangular  parity  as  regards  the  rates  for  London  cables  in 
Paris  and  Paris  cables  in  New  York. 

Alternative  Methods  of  Remitting  in  Triangular  Exchange. — 
There  are  several  other  possible  ways  by  which  funds  may  be 
sent  from  New  York  to  London,  or  the  reverse,  so  far  as  the  three 
centers  considered  are  concerned.  When  remittance  is  made  by 
a  single  direct  exchange,  two  markets,  New  York  and  London,  are 
available  for  the  purpose,  the  remitter  having  the  choice  of  either 
buying  London  exchange  in  New  York  or  selling  New  York  ex- 
change in  London.  If  he  elects  to  remit  by  way  of  Paris,  he  has 
likewise  two  markets  in  which  to  accomplish  each  of  the  two  ex- 
changes, New  York  and  Paris  in  the  one  case,  and  Paris  and  Lon- 
don in  the  other.  He  has,  therefore,  at  his  disposal  four  different 
combinations  of  markets  in  which  to  execute  the  two  exchanges, 
as  against  a  purchase  of  Paris  cables  in  New  York  or  a  sale  of 


TRIANGULAR  EXCHANGE  IO9 

New  York  cables  in  Paris,  he  can  either  purchase  London  cables 
in  Paris  or  sell  Paris  cables  in  London.  In  all,  then,  the  remitter 
has  six  alternative  methods  of  forwarding  funds  from  one  city  ^ 
to  another  in  triangular  exchange.  If  his  transactions  are  large 
and  he  has  the  necessary  facilities  for  executing  triangular  ex- 
changes, he  keeps  careful  watch  on  the  rates  and  chooses  the 
cheapest  method.  As  for  the  arbitrageur  in  triangular  exchange, 
he  has  a  total  choice  of  eight  ways  in  which  to  perform  his  oper- 
ations, since,  for  instance,  against  the  remittance  of  funds  from 
New  York  to  London  via  Paris  by  any  one»of  the  four  methods, 
he  may  either  sell  London  cables  in  New  York  or  purchase  New 
York  cables  in  London. 

Although  we  have  considered  the  question  of  triangular  par- 
ity or  disparity  from  the  standpoint  of  New  York-Paris  exchange, 
having  taken  it  to  be  in  the  one  or  the  other  relationship  to  the 
other  two  exchanges,  it  must  be  remembered  that  parity  or  dis- 
parity of  any  one  exchange  to  the  other  two  necessarily  implies 
the  existence  of  the  same  relationship  in  the  case  of  each  of  the 
exchanges  as  regards  the  remaining  two.  In  other  words,  if 
New  York-Paris  exchange  is  at  disparity  with  New  York-London 
and  Paris-London  exchange,  then  New  York-London  exchange  is 
also  at  disparity  with  New  York-Paris  and  Paris-London  ex- 
change, and  Paris-London  exchange  is  at  disparity  with  New 
York-London  and  New  York-Paris  exchange.  Hence,  with 
triangular  disparity  obtaining,  the  exchange  of  gold  between  any 
two  of  the  three  cities,  in  the  one  or  the  other  direction,  depend-  - 
ing  on  the  nature  of  the  disparity,  is  more  advantageously  effected 
by  way  of  the  third  than  directly. 

Exchange  Effected  through  Two  or  More  Intermediate  Points. 

— Triangular  exchange  is  a  system  of  indirect  remittance  be- 
tween two  cities,  involving  an  exchange  with  an  intermediate 
point.  But  manifestly,  it  is  also  possible  to  remit  from  one  city 
to  another  by  means  of  a  series  of  successive  exchanges  through 


no  FOREIGN  EXCHANGE 

two  or  more  intervening  centers.  For  instance,  a  remittance 
from  New  York  to  London  can  be  made  by  purchasing  succes- 
sively cable  transfers  in  New  York  on  Amsterdam,  Holland,  in 
Amsterdam  cable  transfers  on  Paris,  and  in  Paris  cable  transfers 
on  London.  Remittance  by  such  a  circuitous  route  will  naturally 
be  resorted  to  when  better  results  are  obtainable  than  by  a  more 
direct  method.  A  situation  can  be  conceived  wherein  the  same 
cost  is  entailed  in  remitting  from  one  city  to  any  other,  whether 
it  is  done  by  a  single  direct  exchange  or  by  a  chain  of  consecutive 
exchanges  through  any  number  of  intervening  points.  Indeed, 
the  rates  in  the  various  markets  constantly  tend  to  this  state  of 
universal  parity,  as  they  needs  must  from  the  very  fact  that 
they  are  ever  tending  to  triangular  parity  with  each  other.  The 
possibility  of  their  ever  attaining  this  general  state  of  equilibrium 
in  actual  practice  is,  however,  scarcely  conceivable. 

As  previously  noted,  London  exchange  occupies  a  predom- 
inant position  in  most  of  the  foreign  exchange  markets  of  the 
world  by  reason  of  its  surpassing  all  other  exchanges  in  the  volume 
of  dealings.  On  this  account,  the  rates  in  New  York  for  the  ex- 
changes with  all  the  foreign  centers  other  than  London  are  con- 
trolled by  the  relation  of  the  rate  for  London  exchange  in  New 
York  to  the  rates  for  London  exchange  in  those  foreign  centers  re- 
spectively, precisely  as  in  the  case  of  Paris  cables  in  New  York. 


CHAPTER  VIII 

THE  FOREIGN  EXCHANGE  BANKER 

Hypothetical  Conditions  Discontinued. — The  analysis  of  the 
principles  governing  the  movements  of  the  rates  for  the  various 
classes  of  exchange  being  completed,  the  remaining  chapters  are 
devoted  to  the  practical  phases  of  exchange  operations  as  carried 
on  between  New  York  and  London.  The  hypothetical  conditions 
assumed  in  the  preceding  pages  can,  therefore,  be  dispensed  with. 
In  lieu  of  the  troy  ounce  of  480  grains,  which  under  our  general 
supposition  was  the  monetary  unit  common  to  both  the  United 
States  and  England,  we  shall  henceforth,  except  in  the  one  illustra- 
tion occurring  in  this  chapter,  take  the  two  differing  units  actually 
in  use,  the  dollar  in  the  United  States  and  the  pound  sterling  in 
England;  and,  instead  of  leaving  the  foreign  exchange  banker 
entirely  out  of  account  and  assuming  that  the  exchanges  were 
invariably  conducted  directly  between  the  ultimate  buyers  and 
sellers,  we  shall  hereafter  permit  him  to  play  his  wonted  role  as 
middleman  in  all  transactions. 

Function  of  the  Foreign  Exchange  Bankers. — As  the  inter- 
mediaries through  whose  hands  the  vast  volume  of  exchange 
passes,  the  foreign  exchange  bankers  constitute  the  foreign  ex- 
change market.  They  deal  with  the  original  sellers  and  ultimate 
buyers  of  exchange,  and  also  with  one  another.  The  rates  they 
quote  are  the  regular  market  prices  reported  daily  in  the  press  and 
otherwise  generally  referred  to.  While  exchange  dealers  are  to 
be  found  in  all  the  larger  cities  of  the  country,  they  are  most 
numerous  in  New  York,  where  the  great  bulk  of  the  nation's 
exchange  business  is  transacted.  A  large  portion  of  the  dealings 
in  that  city  represents  purchases  and  sales  made  by  banks  hailing 

III 


0 


112  FOREIGN  EXCHANGE 

from  the  important  points  of  the  interior.  The  foreign  exchange 
market  of  the  entire  country  thus  centers  in  New  York,  and  the 
rates  established  in  the  course  of  deaHngs  there  form  the  basic 
quotations  on  which  business  is  conducted  in  the  minor  markets 
of  the  other  cities. 

The  foreign  exchange  banker,  standing  as  he  does  between 
those  who  have  occasion  to  remit  to  London,  and  those  who  have 
exchange  to  sell,  performs  the  service  of  facilitating  the  entire  pro- 
cess of  money  exchanging  with  foreign  countries.  In  essence  his 
function  is  to  purchase  exchange  in  whatever  amount  and  form 
it  is  offered,  whether  in  the  shape  of  cable  transfers,  demand  or 
long  bills,  for  spot  or  future  delivery,  and  to  resell  it  in  whatever 
amount  and  form  it  is  wanted  by  remitters  and  investors.  He 
serves,  accordingly,  as  a  general  distributing  or  clearing  agent  for 
his  buying  and  selKng  customers,  who  are  thereby  accommodated, 
with  a  minimum  of  delay  and  trouble,  according  to  their  several 
requirements. 

The  banker  always  quotes  a  double  price  for  each  type  of  ex- 
change, if  he  deals  in  them  all,  one  at  which  he  is  willing  to  pur- 
chase, and  the  other,  slightly  higher,  at  which  he  is  prepared  to 
sell.  The  difference  between  these  bid  and  asked  quotations  rep- 
resents the  compensation  he  receives  for  his  service.  It  re- 
quires no  mean  degree  of  trading  skill  and  experience  on  his  part 
to  realize  this  profit,  as  it  is  most  elusive,  owing  to  the  constant 
shifting  of  the  rates.  Nowadays  the  banker  is  obliged  to  operate 
on  a  small  margin  of  profit,  but  as  his  turnover  is  usually  large,  his 
aggregate  earnings  usually  show  a  satisfactory  rate  of  return  on 
the  amount  of  capital  he  devotes  to  his  business. 

Business  of  Foreign  Exchange  Banking. — It  is  not  the  prac- 
tice of  the  foreign  exchange  banker  to  sell  the  identical  cables  and 
bills  he  purchases.  Instead,  he  remits  whatever  exchange  he 
buys  to  London  for  collection  or  discount,  as  the  case  may  be,  and, 
against  the  proceeds,  markets  his  own  bills  and  cables.    Nor  does 


THE  FOREIGN  EXCHANGE  BANKER  II3 

he  necessarily  market  his  exchange  in  the  form  in  which  he  has 
bought  remittances.  On  the  contrary,  more  often  than  not,  in 
turning  over  his  purchases,  he  converts  one  type  of  exchange  into 
another,  depending  upon  which  will  bring  him  the  greatest  gain 
in  view  of  the  existing  prices  for  the  various  classes  of  exchange 
and  the  prevailing  interest  rates  in  New  York  and  London.  The 
most  common  instance  of  such  conversion  is  the  sale  of  demand 
bills  against  the  purchase  of  long  bills  and  their  immediate  dis- 
count in  London.  By  thus  turning  the  exchange  he  buys  into 
the  type  most  in  demand  at  the  moment,  the  banker  enhances  his 
efficiency  as  a  distributing  agent  and  equalizes  the  demand  and 
supply  of  each  class  of  exchange. 

Foreign  Exchange  Banker  Lends  His  Credit. — By  selling  his 
own  bills  and  cables  against  his  purchases  of  exchange,  the  banker 
extends  the  use  of  his  credit  to  his  selling  customers  in  the  case 
of  spot  exchange,  and  to  both  his  selling  and  buying  customers 
in  the  case  of  future  exchange.  In  this  way  he  promotes  exchange 
dealings.  The  buyer  of  spot  demand  or  long  exchange  makes  an 
advance  to  the  seller.  Naturally  then,  he  prefers  to  make  his 
purchases  from  a  middleman  with  an  established  reputation  for 
fair  dealing  and  financial  soundness,  rather  than  from  anyone  with 
whom  he  may  casually  come  into  contact,  of  whose  moral  and  fi- 
nancial responsibility  he  may  be  totally  ignorant.  Hence  by  in- 
terposing himself  between  his  buying  and  selling  customers,  the 
banker  protects  the  former  against  failure  on  the  part  of  the 
sellers  to  make  delivery  in  London,  taking  upon  his  own  shoulders 
whatever  risk  attaches  to  the  purchase  of  exchange.  In  the  case 
of  a  purchase  and  sale  of  future  exchange,  he,  in  effect,  guarantees 
to  both  seller  and  buyer  delivery  by  the  one  to  the  other.  Of 
course,  he  assumes  only  reasonable  risks,  but  as  he  is  an  expert 
in  credits,  thoroughly  posted  on  the  standing  of  his  customers, 
he  can  deal  safely  with  many  who  on  no  accoimt  would  deal  with 
each  other. 


114  FOREIGN  EXCHANGE 

Bank  Balances  of  Foreign  Exchange  Banker.— To  facilitate 
his  operations,  the  exchange  banker  employs  a  certain  amount  of 
capital  in  the  shape  of  a  supply  of  gold,  or  rather  its  equivalent, 
bank  deposits,  a  portion  of  which  he  keeps  at  home  in  New  York 
and  the  remainder  of  which  he  carries  with  one  or  more  bank  cor- 
respondents in  London.  These  two  stocks  serve  him  as  working 
balances.  As  he  purchases  exchange,  he  makes  delivery  out  of 
his  New  York  balance  and  receives  delivery  into  his  London  bal- 
ance; and  vice  versa,  when  he  sells  exchange,  he  receives  delivery 
into  his  New  York  balance  and  makes  delivery  out  of  his  London 
balance.  In  the  ordinary  pursuit  of  his  purely  exchange  business, 
his  sales  approximately  offset  his  purchases,  so  that  his  balances  in 
both  centers  are  merely  turned  over  and  their  amounts  remain 
virtually  unchanged,  except  for  his  profits  or  losses.  To  take  the 
simple  case  of  a  purchase  and  sale  of  spot  cable  transfers,  suppose 
a  banker  buys  a  cable  on  London  for  i,ooo  ounces  at  the  rate  of 
482  grains.  He  adds  1,000  ounces  to  his  London  balance,  and 
pays  i,oo4i  ounces  out  of  his  New  York  balance.  If  a  moment 
later  he  sells  a  cable  for  1,000  ounces  at  the  rate  of  482^  grains,  the 
sale  completely  offsets  the  previous  purchase  so  far  as  the  London 
deliveries  are  concerned,  and  his  London  balance  remains  intact, 
while  his  balance  in  New  York  is  increased  by  f  f  of  an  ounce,  the 
difference  between  what  he  receives  and  pays  out,  or  his  profit  on 
the  turnover.  The  banker's  daily  sales  and  purchases  never,  of 
course,  balance  absolutely,  but  whatever  excess  results  one  way  or 
the  other  is  only  temporary,  if  he  conducts  his  business  on  con- 
servative lines  and  does  not  indulge  in  speculation,  and  it  is 
covered  by  the  balances  he  carries  in  the  two  cities. 

The  foreign  exchange  business  is  principally  in  the  hands  of  the 
large  banks,  trust  companies,  and  private  banking  firms,  which 
maintain  special  departments  for  the  purpose,  in  charge  of  man- 
agers responsible  for  their  success.  The  managers  are  assigned  a 
certain  amount  of  capital  by  the  general  managements,  commen- 
surate with  the  volume  of  business  they  are  expected  to  do,  on 


THE  FOREIGN  EXCHANGE  BANKER  II5 

which  they  are  charged  a  certain  rate  of  interest,  either  the  pre- 
vailing market  rate,  or  some  other  rate  more  or  less  arbitrarily 
fixed.  Their  success  is  judged  by  the  amount  they  earn  over  and 
above  this  rate. 

"  Commercial  Business "  of  Foreign  Exchange  Banker. — 

The  purely  exchange  transactions  of  the  foreign  exchange  banker 
fall  into  two  classes,  commonly  designated  as  his  "commercial 
business"  and  his  "open-market  trading."  The  first  of  these 
embraces  his  dealings  with  customers  and  other  ultimate  buyers^ 
and  sellers,  of  which  the  greatest  proportion  by  far  is  done  with 
importers  and  exporters.  Bills  which  exporters  draw  on  overseas 
importers,  or  on  London  banks  which  accept  the  drafts  in  behalf 
of  those  importers  (see  Chapter  X),  are  referred  to  as  "  commercial 
bills,"  in  contradistinction  to  those  put  out  by  banks,  which  are 
known  as  "bankers'  bills."  As  the  general  credit  rating  of  ex- 
porters is  not  so  high  as  that  of  banks,  commercial  bills  are  mar- 
ketable for  less  than  bankers'  bills,  even  when  drawn  on  prime 
London  banks.  Hence  the  profits  which  banks  derive  from  sell- 
ing their  bills  against  the  purchase  of  commercial  bills  are  primarily 
due  to  the  superior  credit  they  enjoy.  This  source  of  income  is 
the  most  lucrative  of  all,  especially  if  they  have  a  numerous 
clientele  which  deals  with  them  regularly. 

It  is  the  practice  of  conservative  banks-,  which  refrain  from  en- 
tering into  speculative  commitments,  to  market  at  once  the  ex-  ^ 
change  they  buy.  When,  for  example,  they  purchase  a  number 
of  demand  bills,  they  immediately  offset  them  with  sales  of  their 
own  exchange,  generally  in  the  form  of  demand  drafts.  The  two 
sets  of  bills  are  dispatched  by  the  same  steamer  to  London,  and 
balance  each  other  in  the  accounts  carried  with  the  foreign  cor- 
respondents. If  long  bills  are  purchased,  they  are  usually  for- 
warded to  London  for  immediate  discount,  and  demand  bills  are 
sold  at  the  same  time  for  the  amount  of  the  prospective  proceeds. 
The  two  sets  of  bills  travel  to  London  together,  and  the  sums 


Il6  FOREIGN  EXCHANGE 

realized  from  the  sale  of  the  long  bills  go  to  retire  the  demand 
drafts.  Where  banks  carry  the  long  bills  they  purchase  to  matur- 
ity, and  are  at  the  same  time  unwilling  to  speculate  on  the  future 
trend  of  the  spot  rates  of  exchange,  they  take  the  precaution  of 
selHng  future  demand  (or  cables),  or  long  bills  drawn  on  their 
London  correspondents  to  run  for  the  same  length  of  time  as  the 
purchased  bills.  In  marketing  their  long  bills  they  in  reality 
borrow  back  from  London  and  transfer  to  New  York  funds  they 
have  just  remitted  and  invested  in  London. 

Although  the  bulk  of  the  supply  of  exchange  originates  in  mer- 
chandise exports,  only  a  limited  number  of  banks  handle  bills 
growing  out  of  these  shipments.  They  are  those  which  specialize 
more  or  less  in  commercial  credits,  and  are,  therefore,  in  a  position 
to  make  accurate  appraisals  of  the  security  represented  by  com- 
mercial bills.  From  these  purchases  they  supply  remitting  cus- 
tomers with  exchange,  and  the  balance  they  dispose  of  in  the 
open  market  to  banks  which  experience  an  excess  demand  from 
customers.  In  this  manner  the  commercial  exchange,  which 
comes  upon  the  market  through  the  hands  of  a  comparatively 
few  banks,  is  distributed  and  the  demand  for  remittance  is  satis- 
fied in  every  quarter. 

Open-Market  Trading. — In  addition  to  their  dealings  with 
customers,  banks  carry  on  a  considerable  business  in  exchange 
with  each  other.  In  this  open-market  trading  they  not  only  work 
off  whatever  surplus  supplies  of  exchange  they  may  have  on  their 
hands  as  a  result  of  their  purchases  from  customers,  or  satisfy 
any  excess  demand  they  may  experience  from  remitting  clients, 
but  they  also  take  advantage  of  rate  fluctuations  to  make  quick 
^*  turns,"  including  any  existing  disparities  in  the  rates  for  the 
various  forms  of  exchange,  whether  in  New  York,  or  as  between 
New  York  and  London,  or  any  other  center.  These  interbank 
dealings  are  conducted  on  a  wholesale  scale,  being  for  large,  round 
amounts,  and  they  represent  no  small  proportion  of  the  total  ex- 


THE  FOREIGN  EXCHANGE  BANKER  II7 

change  transactions.  The  profits  they  yield  are  the  result  of^ 
shrewd  trading,  and  not  of  any  differences  in  credit  between  the 
buyers  and  sellers,  as  in  the  case  of  the  commercial  transactions, 
for  they  are  mainly  conducted  between  prime  banks,  whose  bills 
and  other  forms  of  exchange  are  quoted  on  an  equal  footing.  To 
a  certain  extent  first-class  banks  also  purchase  the  cheaper  ex- 
change put  out  by  banks  of  inferior  standing,  but  such  transactions 
are  more  properly  classed  with  commercial  dealings.  The  sales  or 
purchases  of  exchange  which  banks  make  against  gold  shipments 
in  and  out  of  the  country  are  usually  effected  in  the  open  market. 

Financial  Operations  of  Foreign  Exchange  Banker. — Closely 
related  to  the  foreign  exchange  banker's  exchange  business  proper 
are  what  may  be  termed  his  financial  operations.  These  consist 
of  lending  for  short  periods  a  portion  of  the  balances  he  carries  in 
the  two  cities,  including  the  transfer  of  a  portion  from  one  city 
to  the  other  for  this  purpose.  His  choice  of  the  particular  market 
in  which  to  make  such  advances  will  depend  upon  the  relative 
position  of  the  prices  quoted  for  spot  and  future  demand  or  cable 
exchange.  If  future  exchange  is  ruling  at  absolute  parity  with 
spot  exchange,  funds  temporarily  transferred  from  one  city  to  the 
other  and  loaned  there  will  yield  precisely  the  same  rate  of  return 
as  they  would  in  the  first  market,  regardless  of  how  the  interest 
rates  of  the  two  cities  may  compare,  provided  the  banker  refuses 
to  incur  any  speculative  risk  and  accompanies  the  transfer  with 
an  offsetting  sale  or  purchase,  as  the  case  may  be,  of  future  ex- 
change. If  in  such  an  exchange  rate  situation  the  banker  is 
carrying  greater  balances  than  the  volume  of  his  exchange 
business  will  probably  require  in  the  next  few  weeks  or  months, 
he  makes  no  transfer,  but  lends  his  surplus  funds  out  in  the 
markets  where  they  happen  to  be. 

When  futures  on  London  are  selling  above  their  parity  with 
spot  exchange,  the  banker  finds  it  more  remunerative  to  remit  and 
lend  in  London  any  surplus  balance  he  may  happen  to  have  in 


Il8  FOREIGN  EXCHANGE 

New  York;  and  this  he  may  do  by  merely  purchasing  long  bills  on 
London  in  New  York.  If  the  disparity  in  the  rates  persists  and 
is  of  sufficient  proportions  to  make  it  worth  while,  he  may  even 
borrow  additional  sums  from  the  general  management  of  the  bank 
for  similar  investment  in  London.  On  the  other  hand,  if  future 
exchange  is  quoted  under  parity  with  spot  exchange,  it  will  ad- 
vantage the  banker  to  recall  and  invest  in  New  York  loans  the 
unemployed  part  of  his  London  balance.  He  may  even  borrow  in 
London  to  lend  in  New  York,  either  by  obtaining  straight  ad- 
vances from  his  correspondent,  or  by  drawing  long  bills  on  the 
correspondent  and  selHng  them  in  the  one  or  the  other  city. 

Miscellaneous  Activities  of  Foreign  Exchange  Banker. — 
The  foreign  exchange  banker  performs  sundry  other  services  for 
his  cHents,  in  addition  to  those  explained  above,  for  which  he 
charges  special  commission  fees.  These  services  in  the  main 
comprise  the  extension  to  importers  of  what  are  known  as  '*  ac- 
ceptance credits,"  to  be  examined  in  a  later  chapter  (Chapter  X), 
or  of  making  arrangements  with  his  London  correspondent  for 
their  extension  in  that  city;  also  the  collection  of  drafts  on  for- 
eign importers  which  are  not  of  a  quahty  to  warrant  their  purchase, 
owing  to  the  unsatisfactory  standing  of  the  drawers,  and  the  sale 
to  exporters  of  credit  information  concerning  foreign  buyers. 

In  prosecuting  his  various  activities  the  exchange  banker  re- 
quires the  services  of  his  London  correspondent  to  no  small  degree. 
For  this  assistance  he  pays  the  London  bank  some  remuneration, 
the  amount  of  which  is  fixed  by  a  standing  arrangement  concluded 
between  them.  In  former  years  it  was  customary  for  London 
correspondents  to  charge  American  banks  a  commission  for 
handling  their  accounts,  which  was  proportioned  to  the  volume  of 
bills  they  cleared.  Nowadays,  however,  far  from  having  to  make 
any  such  payment,  American  banks  are  actually  allowed  interest 
on  their  London  balances.  For  such  special  services  as  the  collec- 
tion of  drafts,  commissions  are  paid  London  banks  now  as  before. 


CHAPTER  IX 

STERLING  CABLE  AND   DEMAND  EXCHANGE  IN 

PRACTICE 

Only  Pre-war  Conditions  Considered. — We  have  assumed 
that  the  American  and  British  monetary  systems  operated  in 
strict  conformity  with  the  gold-standard  principle,  and  that 
New  York  and  London  bank  deposits  were  absolutely  equivalent 
to  corresponding  amounts  of  gold.  This,  of  course,  actually 
was  the  case  prior  to  the  outbreak  of  the  war.  During  the  con- 
flict, however,  the  gold  standard  was  compromised  in  both  coun- 
tries by  the  restrictions  their  governments  were  forced  to  place 
on  gold  exporting,  and  this  was  reflected  in  the  abnormally  low 
rates  to  which  London  and  New  York  exchanges  fell  in  neutral 
centers.  At  the  moment  of  writing  the  rate  situation  is  still 
extremely  irregular  so  far  as  London  exchange  is  concerned,  and 
promises  to  remain  so  for  a  number  of  years  to  come.  We 
shall,  however,  pay  no  attention  to  these  abnormal  conditions 
in  dealing  with  the  practical  aspects  of  exchange,  but  shall  revert 
to  the  period  before  the  war,  when  normal  quotations  prevailed 
for  exchange  between  New  York  and  London. 

The  American  Monetary  System. — Before  proceeding  to  dis- 
cuss the  manner  in  which  business  is  actually  conducted  in  the 
New  York  exchange  market,  we  shall  briefly  examine  the  essen- 
tial features  of  the  monetary  systems  in  the  United  States  and 
England,  that  we  may  see  precisely  why  bank  deposits  in  those 
countries  are  normally  equivalent  to  gold.  We  shall  consider  the 
American  system  first. 

The  American  monetary  unit,  the  dollar,  consists  of  23.22 
grains  of  gold.     But  contrary  to   the  strict  interpretation  of 

119 


120  FOREIGN  EXCHANGE 

the  gold-standard  principle,  certain  demand  obligations  of  the 
government,  as  well  as  gold  coin,  are  full  legal  tender  so  far  as 
private  debts  are  concerned.  These  obligations  include  the 
United  States  notes  or  greenbacks,  the  Treasury  notes  of  1890, 
and  the  silver  dollars.  Moreover,  while  the  government  is 
expressly  bound  by  law  to  redeem  in  gold  the  two  note  issues, 
and  to  maintain  for  the  purpose  a  special  reserve  of  the  metal, 
it  is  not  compelled  by  any  similar  statutory  provision  to  honor 
its  silver  dollars  in  gold.  Unless,  then,  payment  of  gold  is 
specifically  stipulated,  creditors  may  be  forced  to  accept  from 
their  debtors  government  money  the  legal  character  of  which 
is  left  somewhat  in  doubt. 

This  defect  in  the  legal  status  of  the  silver  dollars  is,  however, 
of  no  practical  effect,  as  it  is  virtually  corrected  by  the  Gold 
Standard  Act  of  1900,  which  imposes  upon  the  government  the 
duty  of  maintaining  at  all  times  the  parity  or  equivalence  to 
gold  of  all  forms  of  its  obligations  passing  current  as  money. 
By  this  provision,  whenever  its  currency  notes  and  subsidiary 
coins  (including  the  silver  dollars)  fall  to  a  discount  below  parity 
with  gold,  the  government  must  take  immediate  steps  to  restore 
that  equivalence.  This  it  can  accomplish  only  by  freely  paying 
out  gold  for  the  full  face  amount  of  whatever  obligations  are 
presented  for  payment.  The  necessity  for  such  action,  to  be 
sure,  will  occur  only  on  the  rare  occasions  of  acute  financial 
crises.  Even  in  ordinary  periods,  however,  little  difficulty  is 
experienced  in  procuring  gold  for  the  face  amount  of  the  silver 
dollars  in  the  comparatively  few  instances  when  it  is  wanted. 
Therefore,  the  coins  may  be  considered  as  readily  convertible  into 
gold  as  the  United  States  notes  and  the  Treasury  notes  of  1890, 
and  in  consequence  all  debts  in  the  United  States  are  payable  in 
gold,  either  directly  at  a  place  specified  in  the  contract,  or  indi- 
rectly, through  the  legal  tender  demand  obligations  of  the  govern- 
ment, at  the  Treasury  in  Washington,  or  at  one  of  the  nine 
sub  treasuries  located  in  the  principal  cities  of  the  country. 


STERLING  CABLE  AND  DEMAND  EXCHANGE  121 

Of  the  total  stock  of  gold  in  the  country  available  for  the 
ultimate  redemption  of  debts  in  case  of  necessity,  the  major 
part  is  concentrated  in  the  United  States  Treasury  and  the 
sub  treasuries.  Most  of  the  remainder  is  lodged  in  the  twelve 
federal  reserve  banks,  while  a  comparatively  small  amount  is 
scattered  among  the  thousands  of  ordinary  banks.  But  even 
the  portion  held  by  the  government  is  owned  for  the  most  part 
by  the  federal  reserve  institutions,  since  they  hold  the  bulk  of 
outstanding  gold  certificates,  which  are  but  warehouse  receipts 
for  corresponding  amounts  of  gold  entrusted  to  the  government's 
keeping.  These  regional  banks  are,  therefore,  the  central  gold 
reservoirs,  which  are  drawn  upon,  when  the  metal  is  wanted  in 
any  quantity,  through  banks  that  carry  deposits  in  the  reserve 
banks  as  members  of  the  Federal  Reserve  System.  An  intend- 
ing exporter  of  gold  in  New  York,  for  example,  procures  the 
metal  from  the  New  York  Federal  Reserve  Bank  by  cashing  a 
check  which  he  secures  from  his  bank.  He  is  paid  either  in 
gold  or  gold  certificates.  If  he  receives  certificates,  he  presents 
them  at  the  local  sub  treasury  and  obtains  gold  coin;  or  applies 
to  the  local  assay  office  and  secures  gold  bars.  It  is  perfectly 
evident,  therefore,  that  a  New  York  bank  deposit  is  equivalent 
to  spot  gold  delivered  at  the  bank's  office;  or,  more  likely,  at 
the  neighboring  federal  reserve  bank,  subtreasury,  or  assay  office, 
but  in  any  case  in  New  York. 

The  British  Monetary  System. — The  monetary  system  in 
England  is  constructed  on  simpler  lines  than  the  American 
system.  The  law  defining  the  British  monetary  unit,  the  pound 
sterling,  provides  that  one  troy  ounce,  eleven-twelfths  fine, 
shall  be  coined  into  £3,  17  shillings,  and  10 J  pence,  thereby 
making  the  pure  gold  content  of  the  pound  equal  exactly  to 
1 13  5 1^3  grains.  Prior  to  the  war  only  gold  coin  and  Bank  of 
England  notes  comprised  the  full  legal  tender  money  of  the 
realm.     Since  the  early  days  of  the  conflict,  however,  the  govern- 


122  FOREIGN  EXCHANGE 

ment  has  issued  for  general  monetary  use  its  own  demand 
obligations,  styled  "currency  notes,"  which  it  has  endowed  with 
the  full  legal  tender  quality.  The  bank  notes  are  redeemable 
only  in  gold,  and,  indeed,  are  virtually  nothing  more  than  receipts 
for  actual  gold  deposits  in  the  bank,  since  beyond  a  practically 
fixed  amount,  now  standing  at  £18,450,000,  the  institution  is 
authorized  to  issue  its  notes  only  against  the  deposit,  pound 
for  pound,  of  gold  in  a  separate  department,  known  as  the  "Issue 
Department."  The  currency  notes  are  also  redeemable  exclu- 
sively in  gold,  and  for  that  purpose  the  government  maintains 
a  special  reserve  stock  of  the  metal  in  the  custody  of  the  Bank 
of  England.  Thus,  every  obligation  in  England  to  pay  pounds 
sterling  is  payable  in  gold  upon  the  insistence  of  the  creditor, 
directly  at  a  designated  place,  or,  through  the  medium  of  the 
bank  and  currency  notes,  at  the  Bank  of  England.  Hence, 
deposits  in  London  banks  are  in  normal  times  equivalent  to 
corresponding  amounts  of  spot  gold  delivered  at  their  offices 
or  at  the  Bank  of  England,  that  is  to  say,  in  London. 

Sterling  and  Dollar  Exchange. — In  passing  to  a  consideration 
of  the  practical  operations  in  New  York -London  exchange,  it  is 
first  necessary  to  define  the  manner  in  which  the  terms  "sterling 
exchange"  and  "dollar  exchange"  are  commonly  used.  In 
allusion  to  the  fact  that  London  bank  deposits  and  bills  on  Lon- 
don are  expressed  in  terms  of  the  British  monetary  unit,  London 
exchange  is  more  frequently  referred  to  as  "sterling  exchange." 
The  phrase,  however,  lacks  precision,  since  it  may  be  applied 
with  equal  propriety  to  bank  deposits  in  any  British  city.  Still, 
as  banking  in  England  is  centralized  in  London  to  such  an  extent 
that  practically  all  the  principal  banks  of  the  country  maintain 
their  head  offices  in  that  city,  if  British  funds  are  used  in  the 
settlement  of  international  indebtedness,  it  is  almost  invariably 
London  deposits.  Hence,  unless  otherwise  stated,  sterling  ex- 
change is  understood  to  have  reference  to  London  funds. 


STERLING  CABLE  AND  DEMAND  EXCHANGE  1 23 

In  the  same  manner  New  York  exchange  is  more  often  alluded  "^ 
to  as  *' dollar"  or  *' American  exchange,"  but  these  expressions 
are  open  to  the  same  objection  as  the  term  ''sterling  exchange," 
since  they  can  likewise  be  applied  to  bank  deposits  in  any  Ameri- 
can city.  Nevertheless,  since  the  major  part  of  the  exchanges 
between  London  and  this  country  are  executed  with  New  York, 
"dollar"  or  "American  exchange"  usually  means 'New  York 
exchange.  In  the  following  pages  "sterling  exchange"  and 
"dollar  exchange"  will  be  taken  to  refer  exclusively  to  London 
and  New  York  exchange,  respectively. 

Rates  Expressed  in  Dollars  in  Both  Cities, — The  New  York 
market  always  quotes  the  rates  for  sterling  exchange  in  terms 
of  dollars  to  the  £1  sterling.  A  rate  of  $4.86  (commonly  ex- 
pressed without  the  dollar  sign)  means  simply  that  112.8492 
grains  (4.86  X  23.22)  of  New  York  gold  will  exchange  for  £1 
sterling,  or  113^!-^  grains  of  London  gold.  As  the  gold  content 
of  $4.8665  is  equal  to  that  of  £1  sterling  (4.8665  X  23.22  = 
approximately  113-5^1-3),  a  rate  of  $4.8665  indicates  that  New 
York  funds  are  exchanging  for  London  funds  on  even  terms,  and 
the  figure,  accordingly,  represents  the  par  of  exchange  between 
the  two  centers.^ 

As  the  rate  for  sterling  exchange  is  expressed  in  domestic  gold, 
or,  according  to  what  we  have  designated  the  first  method,  of 
quotation,  an  advance  in  the  figure  above  $4.8665  signifies  a 
premium  on  the  exchange.  If,  for  example,  the  rate  is  $4.88, 
ii3^|-3-  grains  of  London  gold  is  exchangeable  for  1 13.3 136  grains 
(4.88  X  23.22)  of  New  York  gold,  or  at  a  premium  of  .312  of  a 
grain.  On  the  other  hand,  when  the  rate,  is  ruling  under  $4.8665, 
113  g^l^g-  grains  of  London  gold  exchange  for  less  than  that  amount 
of  New  York  gold,  and  the  rate  is  accordingly  at  a  discount.     If 

'  The  par  of  exchange  between  New  York  and  London  may  also  be  denoted 
by  the  fraction  of  £1  sterling  equivalent  to  ^i,  which  is  £.20549  (.20549  X 
ii3«¥3  =  approximately  23.22). 


124  FOREIGN  EXCHANGE 

the  rate  is  $4.85,  113^^  grains  of  London  gold  will  bring  only 
1 1 2.61 7  grains  (4.85  X  23.22)  of  New  York  gold,  which  represents 
a  discount  of  .3846  of  a  grain. 

Moreover,  London  dealers  quote  dollar  exchange  in  dollars 
or  New  York  funds.  The  rates  being  thus  expressed  in  foreign 
gold,  or  according  to  the  second  system  of  quotation,  New  York 
exchange  commands  a  premium  when  the  figure  by  which  its 
rate  is  indicated  falls  below  the  par  of  $4.8665,  and  sells  at  a 
discount  when  the  figure  advances  above  $4.8665.  Thus,  when 
the  rate  is  $4.85,  it  takes  113^  J^  grains  of  London  gold  to  obtain 
1 1 2. 61 7  grains  of  New  York  gold,  which  is  then  at  a  premium. 
Contrariwise,  when  the  rate  is  $4.88,  113^2-3-  grains  of  London 
gold  command  1 13.3136  grains  of  New  York  gold,  which  is 
then  at  a  discount. 

Since  both  places  quote  their  exchange  rates  in  terms  of 
New  York  funds,  their  cable  rates,  which,  as  we  have  seen, 
constantly  make  for  equality,  tend  to  be  expressed  by  the  same 
identical  figure.  Thus,  when  sterling  cables  in  New  York  are 
ruling  at  $4.86,  the  rate  for  dollar  cables  in  London  likewise  tends 
to  be  $4.86,  at  which  price  112.8492  grains  of  New  York  funds 
exchange  for  1136^!^  grains  of  London  funds  in  both  markets. 

As  for  the  figures  denoting  the  demand  rates  in  the  two 
centers,  that  in  New  York  always  rules  below  the  cable  quota- 
tion, since  it  refers  to  local  funds  and,  therefore,  tends  to  be 
equal  to  the  cable  rate  discounted  at  the  London  rate  of  interest 
for  the  current  maiHng  period  (see  page  73).  If,  for  instance, 
the  cable  rate  is  $4.86  and  the  London  interest  rate  is  4%  per 
annum,  while  the  voyage  to  London  by  the  next  mail  steamer  is 
10  days  long,  the  demand  parity  of  the  cable  rate  is  $4.8546, 
which  quotation  signifies  that  112.7238  grains  (4.8546  X  23.22) 
of  New  York  funds  paid  now,  exchange  for  113 ^Iy  grains  of 
London  funds,  paid  when  the  next  mail  is  delivered  in  London.  ^ 

*  In  actual  practice  interest  is  figured  on  the  basis  of  the  full  year  of  365 
days. 


STERLING  CABLE  AND  DEMAND  EXCHANGE  1 25 

It  was  customary  before  the  war,  however,  for  dealers  to  quote 
demand  exchange,  as  well  as  cables,  in  regular  variations  of  ^^  of 
a  cent,  as  $4,867^6,  $4.86^,  $4.86x^9,  etc.,  or  in  variations  of  .05  of 
a  cent,  as  $4.8605,  $4.8610,  $4.8615,  etc.  The  demand  rate  in  the 
preceding  example  would  in  practice  be  taken  to  be  the  nearest 
quotable  variation,  or  $4.8545. 

On  the  other  hand,  the  figure  representing  the  demand  rate 
for  dollar  exchange  in  London  is  always  above  that  for  cable 
transfers,  since  the  demand  parity  of  the  prevailing  cable  rate 
there  is  equal  to  the  cable  quotation  plus  interest  at  the  New 
York  rate  for  the  time  it  will  take  the  next  mail  steamer  to  deliver 
drafts  in  New  York  (see  page  83).  If  the  cable  rate  is  $4.86, 
the  annual  interest  rate  in  New  York  6%,  and  10  days  are  re- 
quired at  the  moment  to  send  mail  to  New  York,  then  the  de- 
mand parity  of  the  cable  rate  is  $4.8680,  or  to  express  the 
full  ratio  in  terms  of  grains,  nsei^s  grains  of  London  funds 
paid  now,  against  113.035  grains  (4.8680  X  23.22)  of  New  York 
funds  paid  10  days  later. 

Trading  in  Cable  Transfers. — In  deaHng  with  the  practical 
features  connected  with  trading  in  cable  and  demand  exchange 
in  the  New  York  market  we  shall  begin  with  the  cable  transfer, 
the  simpler  of  the  two  classes  of  remittance.  A  simple  case  will 
illustrate  its  operation.  Suppose  bank  A  in  New  York,  whose 
London  correspondent  is  bank  C,  purchases  from  bank  B  in  New 
York,  whose  London  correspondent  is  bank  Z>,  a  spot  cable  for 
£10,000  (2,354  ounces,  90  grains  of  London  funds),  paying  for  it 
a  rate  of  $4.86,  or  a  total  of  $48,600  (2,351  ounces,  12  grains  of 
New  York  funds).  Sometime  in  the  course  of  the  day,  bank  B 
dispatches  a  cablegram  to  bank  D  directing  it  to  pay  bank  C 
for  account  of  bank  ^,  £10,000  out  of  its  (B's)  balance.  But  as 
London  time  is  a  little  over  5  hours  in  advance  of  New  York  time, 
the  message  does  not  reach  London  early  enough  to  be  acted 
upon  on  the  day  it  is  sent,  and  the  payment  is  in  consequence 


126  FOREIGN  EXCHANGE 

deferred  until  the  next  day.  On  the  other  hand,  bank  A  does 
not  pay  for  the  transfer  in  New  York  until  it  has  received  on 
this  second  day  cable  confirmation  from  its  London  correspondent 
that  the  £10,000  has  been  paid  into  its  account.  Thus  payment 
of  the  funds  in  the  two  cities  in  the  case  of  a  cable  transfer  is 
not  made  until  the  day  following  the  conclusion  of  the  contract. 

While  this  is  the  regular  way  in  which  New  York  banks  settle 
contracts  in  spot  cables  with  each  other,  purchases  of  this  remit- 
tance are  occasionally  made  by  them  for  ^'cash"  or  immediate 
payment  in  New  York.  For  thus  anticipating  the  ordinary  day 
of  payment,  the  buying  bank  is  allowed  a  day's  interest  by 
being  charged  a  correspondingly  lower  rate.  Such  cash  trans- 
actions ordinarily  take  place  when  the  selling  bank  wants  funds 
in  New  York  and  finds  a  purchasing  bank  willing  to  accommodate 
it  on  those  terms.  They  are  the  rule  on  days  preceding  holidays 
in  New  York,  when  payment  on  the  following  day  is  precluded 
by  the  suspension  of  business.  But  where  the  buyers  are  other 
than  banks — importers  for  instance — the  selling  bank  requires 
immediate  payment  at  the  rate  applying  to  transactions  settled 
in  the  regular  way  between  banks. 

Aside  from  these  cash  dealings,  no  distinction  is  made  in  the 
market  between  the  spot  cables  sold  by  the  various  banks,  or 
between  bankers'  cables  on  the  one  hand,  and  commercial 
cables  sold  by  importers  and  other  non-dealers,  on  the  other. 
"A  cable  is  a  cable,"  as  the  saying  goes,  and  all  command  the 
same  rate.  For  unlike  sight  or  long  bills,  which  are  graded  with 
reference  to  the  standing  of  the  drawers  and  are  quoted  accord- 
j  ingly,  the  element  of  credit  does  not  enter  into  spot  cable  trans- 
^  actions,  since  the  buying  bank  does  not  part  with  its  funds  in 
New  York  until  it  has  been  advised  by  its  London  correspondent 
that  the  exchange  it  purchased  has  been  paid  into  its  account. 

Trading  in  Demand  Exchange.— In  demand  exchange,  trad- 
ing in  the  drafts  is  necessarily  for  successive  mail-carrying  steam- 


STERLING  CABLE  AND  DEMAND  EXCHANGE  I27 

ships,  which  sail  for  England  at  intervals  of  several  days.  Most 
of  the  deahngs  are  for  the  ''mail,"  or  the  liner  which  will  deliver 
the  drafts  first  on  the  other  side.  By  the  practice  of  the  market 
sellers  do  not  deliver  the  drafts  until  the  day  before  the  mail 
sails,  and  receive  payment  on  the  day  of  its  departure.  If  the 
mail  leaves  on  a  Sunday  or  a  holiday,  trading  is  done  for  cash 
the  day  before.  While  this  rule  of  settlement  applies  as  between 
banks,  and  in  respect  to  large,  well-known  importers,  other 
buyers  of  less  satisfactory  standing  pay  for  and  receive  the 
drafts  when  the  bargains  are  closed,  regardless  of  the  time  the 
mail  sails,  and  are  allowed  no  interest  for  their  prepayments. 

As  a  precaution  against  their  loss  by  the  sinking  of  the  vessel 
which  is  to  carry  them,  demand  drafts  are  made  out  in  duplicate,  i 
and  the  two  parts,  which  are  known  as  *Hhe  first  of  exchange" 
and  ^'  the  second  of  exchange,"  are  forwarded  by  different  steam- 
ships. If  the  original,  which  is  dispatched  by  the  fastest  mail, 
reaches  its  destination  and  is  paid,  the  duplicate  becomes  void; 
otherwise  it  replaces  the  original.  By  the  same  vessel  which 
carries  the  ''first  of  exchange,"  the  selling  bank  transmits  to  its 
London  correspondent  an  advice  of  its  having  sold  the  draft.-' 
In  accordance  with  the  universal  custom  of  London  banks,  the 
correspondent  charges  the  account  of  the  New  York  drawing 
bank  immediately  upon  receipt  of  the  advice,  irrespective  of 
whether  it  has  cashed  the  draft  as  yet  or  not.  If  the  arrival  of 
the  steamship  on  the  other  side  is  delayed  beyond  the  scheduled 
time,  the  resulting  interest  loss  is  borne  by  the  remitter  of  the 
bill.  It  is  the  chance  he  is  compelled  to  take  in  purchasing  the 
exchange. 

As  soon  as  the  mail  for  a  particular  steamer  has  closed, 
trading  immediately  commences  for  the  vessel  that  will  deliver 
mail  in  London  next.     Delivery  of  the  drafts  is  again  made  the  ^ 
day  before  the  vessel's  departure,  and  payment  on  the  day  it^ 
sails.     The  process  is  repeated  with  the  sailing  of  each  fast  mail 
steamer.    Unless  counteracted  by  a  change  in  the  London 


128  FOREIGN  EXCHANGE 

interest  rate,  the  price  of  demand  exchange  rises  and  falls  in 
relation  to  the  cable  quotation  with  the  speed  of  the  successive 
mail-carrying  vessels.  Not  infrequently  business  is  done  in 
demand  exchange  for  the  slower  mails,  at  rates  slightly  lower 
than  the  mail  rate. 

At  times,  demand  exchange  is  sold  between  banks  for  cash 
or  immediate  payment,  regardless  of  the  time  the  next  mail 
sails.  In  such  cases  the  selling  bank  allows  the  buying  bank  a 
deduction  from  the  ruling  rate,  as  interest  for  the  few  days'  pay- 
ment is  anticipated.  Transactions  of  this  sort  take  place  when 
buying  banks  wish  to  make  a  few  days'  investment,  and  the 
selling  banks  desire  immediate  funds  in  New  York. 

Standard  Quotations  and  Speculative  Risks. — Demand  ex- 
change is  quoted  variously  at  any  one  time,  depending  upon 
the  standing  of  the  drawers  of  the  bills,  but  the  standard  quota- 
tion, regularly  published  in  the  daily  press,  is  the  one  pertaining 
to  large  transactions  in  prime  bankers'  bills,  generally  running 
in  amount  from  ten  to  several  hundred  thousand  pounds  ster- 
ling. Bills  of  the  smaller  dealers  sell  for  .05,  .10,  or  .15  of  a  cent 
under  the  current  rate  for  the  highest  grade  drafts,  according  to 
the  market's  estimate  of  their  drawers'  credit.  Commercial  de- 
mand bills,  issued  by  exporters  and  others  who  are  not  exchange 
dealers,  are  also  quoted  lower  than  prime  bankers'  bills. 

To  avoid  taking  speculative  risks,  conservative  banks  usually 
lose  no  time  in  selling  the  exchange  they  purchase.  Demand 
exchange,  however,  lends  itself  as  a  convenient  medium  of 
speculation  over  a  period  of  several  days  for  banks  which  pursue 
a  less  cautious  policy,  as  it  does  not  necessitate  the  locking  up  of 
any  capital.  If  the  next  mail's  departure  is  a  few  days  off,  and 
the  banks  anticipate  an  advance  in  the  demand  rate,  they  pur- 
chase demand  exchange  and  subsequently  cancel  their  commit- 
ment by  selling  their  own  bills  for  the  same  mail.  If  they  count 
on  a  decline  in  the  rate  in  the  next  several  days,  they  sell  their 


STERLING  CABLE  AND  DEMAND  EXCHANGE  129 

bills  and  later  purchase  cover  in  the  shape  of  demand  bills,  which 
they  remit  by  the  same  steamer.  Should  they  subsequently 
care  to  extend  the  period  of  their  speculation,  they  wait  until 
the  mail  is  due  in  London  and  then  sell  spot  cables,  if  they  have 
purchased  demand  exchange;  or  purchase  spot  cables,  if  they 
have  sold  demand  exchange. 

/ 

"Swapping"  Demand  Exchange  for  Cables. — Banks  occa- 
sionally execute  with  each  other  direct  exchanges  of  demand 
bills  for  cable  transfers,  which  in  the  parlance  of  market  traders 
are  termed  "swaps."  A  bank  with  a  surplus  of  London  funds 
temporarily  on  its  hands,  and,  therefore,  in  possession  of  a  supply 
of  cables,  may  want  to  invest  them  for  the  mailing  period  by 
acquiring  demand  bills  in  their  places.  While  it  can  procure  the 
bills  by  means  of  two  consecutive  exchanges,  the  sale  of  cables 
and  the  purchase  of  demand  exchange  with  the  proceeds,  it 
will  ordinarily  prefer  the  single  direct  exchange. 

"Swapping"  consists  of  the  exchange  of  spot  London  gold 
for  future  London  gold  dehverable  at  the  end  of  the  current 
mailing  period.  It  is,  therefore,  in  reality  a  London  loan  con- 
tracted between  parties  residing  in  New  York.  The  swap  is 
made  on  the  basis  of  the  prevailing  rates  for  the  two  forms  of 
exchange.  The  amounts  exchanged  are  equal,  and  the  owner  / 
of  the  demand  exchange  pays  the  owner  of  the  cable  the  differ-^ 
ence  between  the  rates,  which  represents  interest  at  the  London 
rate  on  the  loan,  converted  into  New  York  funds.  To  take  an 
example,  suppose  bank  A  swaps  with  bank  B  £10,000  of  demand 
exchange  for  a  similar  amount  of  cable  transfers,  on  the  basis 
of  $4.85  for  demand  exchange  and  $4.8550  for  cables.  In  addi- 
tion to  dehvering  £10,000  of  demand  bills,  bank  A  pays  bank  B 
$.005  per  £1  exchanged,  or  $50  in  all. 

In  the  same  manner,  prime  demand  bills  are  swapped  for 
demand  bills  selling  for  lower  prices,  whether  bankers'  or  com- 
mercial.   The  transaction  consists,  in  this  case,  of  the  exchange 


130  FOREIGN  EXCHANGE 

of  two  London  loans,  both  running  for  the  time  it  takes  to  mail 
the  drafts  to  London,  and  one  bearing  a  higher  interest  rate  than 
the  other.  Here  again  the  amounts  exchanged  are  the  same, 
and  the  difference  in  the  interest  rates  is  settled  in  New  York. 
Thus,  if  a  prime  bill  for  £10,000  is  swapped  for  a  lower  grade  bill 
of  the  same  amount,  on  the  basis  of  $4.8510  for  the  former  and 
$4.85  for  the  latter,  the  drawer  of  the  second-rate  bill  pays  the 
drawer  of  the  prime  bill  $.001  per  £1  exchanged,  or  $10  on  the 
entire  swap. 

Gold  Shipments. — Coming  now  to  the  specie  points,  the 
maximum  distances  the  rates  for  cable  and  demand  exchange 
can  move,  above  and  below  the  par  of  $4.8665,  are  fixed  by  the 
cost  of  exporting  and  importing  the  precious  metal,  including 
whatever  interest  loss  is  suffered  on  the  shipments.  Moreover, 
as  the  sterling  rates  in  New  York  pass  beyond  their  export 
points,  the  dollar  rates  in  London  tend  to  fall  below  their  import 
points,  and  vice  versa.  While  consignments  may,  therefore,  be 
undertaken  concurrently  by  banks  in  both  centers,  it  is  generally 
•  New  York  institutions  which  are  responsible  for  the  movements 
of  the  metal,  as  is  natural  in  view  of  the  fact  that  New  York  is 
the  broader  market  of  the  two  for  the  exchange  of  New  York 
and  London  funds,  and  normally  dominates  the  London  market. 
Ordinarily  not  more  than  a  half-dozen  New  York  banks  par- 
ticipate in  a  gold  movement,  and  while  as  a  rule  they  act  indi- 
vidually, they  sometimes  enter  into  joint-account  arrangements 
with  their  London  correspondents  and  share  with  them  the 
profits  of  the  shipments. 

A  bank  may  offset  a  shipment  of  gold  to  London  with  a  sale 
of  demand  exchange,  spot  cables,  or  future  cables,  as  previously 
noted,  while  against  an  importation  of  gold  it  may  buy  demand 
exchange,  discountable  long  bills,  spot  cables,  or  future  cables. 
For  a  practical  illustration  of  the  manner  in  which  it  computes 
the  profit  it  can  realize  on  a  transfer  of  the  metal,  the  case  of  an 


STERLING  CABLE  AND  DEMAND  EXCHANGE  13I 

export  shipment  made  against  the  sale  of  demand  exchange  will 
suffice.  An  example  of  such  a  transaction  is  presented  in  the 
table  below.  The  first  part  of  the  table  includes  the  amount  of 
the  shipment  and  the  various  charges  the  bank  incurs  on  it  in 
New  York,  the  total  representing  the  amount  of  New  York  funds 
the  bank  devotes  on  all  accounts  to  the  consignment.  The 
second  part  sets  forth  the  several  items  of  expense  the  bank  will 
be  put  to  in  London  and  the  net  amount  it  will  realize  from 
the  shipment  after  paying  these  expenses,  which  represents  the 
volume  of  demand  bills  it  can  sell  when  it  makes  the  consignment. 

Total  Amount  of  New  York  Funds  Devoted  to  Shipment 

Amount  exported  in  bars ^1,000,000.00 

Interest  at  5%  for  2  days 

Assay  office  premium  on  bars,  yty% 

Packing,  cartage,  etc 

Freight,  -^% 

Marine  insurance,  ■^% 

Amount  and   cost   of   shipment    in 
New  York ^ 

Amount  of  Shipment  Netted  in  London 

Grains 

Total  shipment £205,486.48  23,220,000 

Grains 
Discount  in  market  price 

6^3 £329-51      37,271 

Interest  at  4%  for  3 
days  on  10%  of  ship- 
ment   6.75  763* 

Miscellaneous  expenses.         120.00      13,560 


Grains 

u 

,000,000.00 

23,220,000 

273-97 

6,361 

500.00 

11,610 

50.00 

1,161 

1,000.00 

23,220 

500.00 

11,610 

$1 

,002,323.97 

23,273,962 

Aggregate  deducted  from  shipment 456.26  51,594 

Amount  netted  in  London £205,030.22  23,168,406 

Amount  realized  on  sale  of  £205,030.22  of 

demand  bills  at  ^4.8910 ^1,002,802.80  23,285,081 

Amount  and  cost  of  shipment  in  New  York. .  1,002,323.97  23,273,962 


Profit  realized $  478.83  11,119 


132  FOREIGN  EXCHANGE 

Several  items  in  the  above  table  require  some  explanation. 
The  2  days'  loan  in  New  York  represents  the  loss  of  interest  on 
the  consignment  while  it  is  being  prepared  for  shipment,  as  the 
proceeds  from  the  sale  of  the  demand  bills  are  not  available 
until  the  day  of  the  vessel's  departure.  For  the  gold  bars  the 
bank  secures  from  the  assay  office  it  pays  a  premium  of  50  cents 
per  $1,000.  In  other  words,  the  bank  must  surrender  claims 
upon  the  government  for  23,231.61  grains  to  obtain  23,220 
grains  in  the  bar  form.  While  no  similar  charge  is  made  for 
gold  coin  by  the  subtreasury,  nevertheless  the  bank  prefers  bars 
to  coin,  since  the  loss  resulting  from  the  export  of  the  latter,  due 
'  to  their  abraded  condition,  is  generally  greater  than  the  premium 
charged  on  bars. 

Final  Disposition  of  Gold  Shipment. — On  its  arrival  in 
i^London  the  metal  is  sold  (exchanged  for  a  London  bank's  prom- 
ise to  pay  gold  on  demand)  at  a  slight  discount  to  compensate 
the  buyer  for  the  loss  of  interest  he  sustains  during  the  few  days 
it  is  being  minted  into  sovereigns.  The  rate  of  discount  allowed 
varies  with  the  state  of  competition  in  the  gold  market,  but  in 
no  event  can  it  exceed  g^J-g,  as  the  Bank  of  England  is  compelled 
by  law  to  purchase  at  no  greater  discount  all  the  gold  it  is  offered.  ^ 
Furthermore,  as  the  buyer  of  the  metal  customarily  advances 
only  90%  of  the  purchase  price  until  its  comparative  fineness 
is  verified  by  approved  London  assayers,  the  New  York  shipping 
bank  is  obliged  to  secure  in  the  meantime  a  loan  for  the  balance 
from  its  London  correspondent,  in  order  to  protect  the  entire 
amount  of  demand  bills  it  has  sold  against  the  shipment. 

According  to  the  table,  on  a  shipment  of  $1,000,000 
(23,220,000  grains)  the  bank  incurs  charges  in  New  York  total- 
ing  $2,323.97    (53,962    grains).     It,    therefore,    devotes   in    all 

^  The  law  provides  that  the  bank  shall  pay  no  less  than  £3,  17  shillings,  9 
pence  for  an  ounce  of  gold  eleven-twelfths  fine,  that  is,  for  X3,  17  shillings, 
10  J  pence  of  British  standard  gold. 


STERLING  CABLE  AND  DEMAND  EXCHANGE  1 33 

$1,002,323.97  (23,273,962  grains)  to  the  consignment.  The 
several  expense  items  it  will  pay  in  connection  with  the  ship- 
ment in  London  are  computed  at  £456.26  (51,594  grains).  This 
sum  deducted  from  the  amount  of  the  consignment  will  leave  an 
available  balance  in  London  of  £205,030.22  (23,168,406  grains),  ^y 
which  represents  the  amount  of  demand  bills  the  bank  can  sell 
against  the  shipment. 

Should  the  bank  receive  $1,002,323.97  for  this  amount  of 
demand  exchange,  which  means  a  rate  of  $4.8887,  it  will  come 
out  even  on  the  transaction,  neither  making  a  profit  nor  suffering 
a  loss.  Under  the  conditions  assumed,  then,  $4.8887  is  the  gold 
export  rate  for  demand  exchange.  Suppose,  however,  the  market 
rate  is  ruling  above  this  specie  point,  and  the  bank  succeeds  in 
selling  the  £205,030.22  of  demand  exchange  at  an  average  rate 
of  $4.8910.  Its  receipts  will  total  $1,002,802.80  (23,285,081 
grains),  or  $478.83  (11,119)  grains  in  excess  of  the  amount  and 
expense  of  shipment.  This  latter  amount  represents  its  profit. 
To  sum  up  the  transaction  in  terms  of  grains,  by  shipping 
23,220,000  grains  of  gold,  and  at  the  same  time  receiving 
23,285,081  grains  in  New  York  in  exchange  for  the  23,168,406 
grains  the  shipment  will  net  it  in  London,  the  bank  will  realize 
a  profit  of  11,119  grains  in  New  York. 

Future  Sterling  Exchange. — In  another  chapter  (see  page  55) 
it  was  shown  that  the  supply  and  demand  for  future  exchange 
emanated,  first,  from  those  who  were  to  receive  or  make  payment 
in  London  at  a  certain  future  time,  and  secondly,  from  specu- 
lators. It  may  now  be  noted  that  foreign  exchange  bankers 
also  can  create  an  original  demand  or  supply  of  future  exchange 
by  converting  futures  into  spot  exchange,  or  conversely.  Such 
conversions  consist  of  arbitrage  operations  between  the  two 
species  of  exchange,  and  are,  of  course,  undertaken  only  when  the 
spot  and  future  rates  are  at  disparity  with  each  other  and  afford 
arbitrageurs  an  opportunity  for  making  a  profit. 


r34  FOREIGN  EXCHANGE 

To  take  the  simple  case  of  a  conversion  of  sterling  future  cables 
into  sterling  spot  cables;  suppose  the  spot  price  is  $4.86  and  the 
price  of  a  future  running  for  one  month  is  $4.8650,  while  interest 
for  this  period  is  at  the  per  annum  rate  of  6%  in  New  York  and 
4%  in  London.  Under  these  circumstances  the  future  parity  of 
the  spot  price  is  $4.8680,  or  the  sum  of  the  spot  price  and  interest 
thereon  at  the  New  York  rate  for  the  period  of  the  future,  dis- 
counted for  the  same  period  at  the  London  rate  of  interest  (see 
page  59).  The  situation  is  one,  therefore,  in  which  the  prevail- 
ing future  rate  is  below  parity  as  regards  the  spot  cable  rate, 
and  the  disparity,  accordingly,  makes  profitable  an  arbitrage 
operation  between  the  sale  of  spot  cables  and  the  purchase  of 
future  cables  (see  page  61). 

Assume  now  that  a  banker  sells  spot  cables  to  the  amount  of 
£10,000,  against  a  i -month  loan  he  contracts  in  London  for 
that  amount;  and  that  he  purchases  at  the  same  time  as  cover  for 
the  principal  and  interest  a  i-month  future  cable  for  £10,033^. 
At  the  rate  of  $4.86  the  sale  of  the  spot  cable  nets  him  $48,600, 
which  sum  he  lends  for  a  month,  or  until  payment  on  the  future 
cable  is  due.  At  the  end  of  that  time  he  will  receive  $48,843  and 
pay  out  $48,812.17  (10,033^  times  $4.8650).  His  profit  will 
amount  to  $30.83. 

It  is  thus  apparent  that  owing  to  the  actual  future  rate  being 
below  the  future  parity  rate  the  banker  can  profitably  convert 
future  cables  into  spot  cables  and  thereby  create  an  original 
demand  for  futures.  In  the  reverse  case  of  disparity  between 
the  two  rates  when  tjie  ruling  future  rate  is  above  the  future 
parity  rate,  he  has  the  opportunity  of  making  the  opposite  con- 
version, the  sale  of  futures  against  the  purchase  of  spot  exchange, 
and  thereby  creating  a  supply  of  futures.  Not  infrequently  the 
sale  of  the  one  and  the  purchase  of  the  other  form  of  exchange  is 
made  with  the  same  party  on  a  single  contract.  In  this  case  the 
conversion  is  known  as  a  swap. 


CHAPTER  X 

COMMERCIAL  AND  BANKERS^  LONG  STERLING 

BILLS 

Financing  Exports  by  Long  Sterling  Bills. — Long  sterling  bills 
of  the  commercial  variety,  originating  in  merchandise  exports, 
differ  from  each  other  in  maturity,  security,  and  the  manner 
in  which  they  are  handled,  being  adapted  in  every  case  to 
the  conditions  of  the  particular  transactions  giving  rise  to 
them.  In  some  established  export  trades  carried  on  by  large 
firms  of  recognized  standing,  however,  certain  standard  types 
of  drafts  have  been  evolved  to  meet  the  general  require- 
ments of  the  trades.  Probably  the  most  representative  of  these 
is-  the  cotton  bill  drawn  against  shipments  of  that  staple,  which 
normally  constitute  the  largest  single  item  in  the  total  export 
commerce  of  the  country.  A  cotton  consignment  is  well  suited, 
therefore,  to  exemplify  the  general  manner  in  which  exports  are 
financed  by  means  of  long  sterling  bills. 

The  Cotton  Bill. — The  cotton  bill  is  usually  drawn  at  60 
days'  sight.  But  as  British  law  allows  debtors  3  days  of  grace, 
the  bill  is  actually  payable  63  days  after  it  is  accepted.  Accord- 
ingly, if  in  a  given  instance  it  requires  15  days  for  the  bill  to 
reach  the  British  drawee  after  it  leaves  the  hands  of  the  American 
drawer,  the  buyer  of  the  cotton  is  extended  credit  for  a  total  of 
78  days.  Within  this  time  he  may  receive  and  even  dispose  of 
the  consignment. 

The  bill  is  usually  drawn  not  against  the  British  importer 
himself,  but  against  his  London  bank,  which  engages  to  lend 
him  its  credit  by  accepting  the  draft  in  his  behalf.  In  making 
this  arrangement  he  is  said  to  establish  an  acceptance  or  reim- 

135 


^ 


136  FOREIGN  EXCHANGE 

bursement  credit  in  favor  of  the  American  shipper.  The  agree- 
ment he  enters  into  with  the  bank  stipulates  the  various  condi- 
tions under  which  the  credit  may  be  used — the  amount  the  bill 
is  to  be  drawn  for  (the  aggregate  amount,  if  several  bills  are  to 
be  drawn  under  the  one  credit  against  as  many  shipments),  its 
maturity,  the  time  within  which  the  shipment  must  be  made 
and  the  draft  drawn,  and  the  documents  which  are  to  accompany 
the  bill,  such  as  the  bill  of  lading,  the  marine  insurance  certificate, 
the  shipper's  invoice,  and  any  other  papers  that  may  be  required. 
The  contract  also  contains  an  engagement  on  the  part  of  the 
British  importer  to  furnish  the  bank,  several  days  before  the 
bill's  maturity,  the  funds  necessary  to  meet  it. 

Before  an  American  bank  will  purchase  the  cotton  bill  from 
the  exporter,  it  will  wknt  to  be  assured  that  the  London  drawee 
bank  has  consented  to  accept  the  bill.  Generally  speaking,  there 
is  no  difficulty  on  this  score  in  the  cotton  export  trade,  since  the 
business  is  for  the  most  part  in  the  hands  of  large,  responsible 
firms,  well  known  to  the  banks,  and  their  implied  word  when 
offering  the  bills  for  sale  is  sufficient  guarantee  that  the  London 
banks  will  honor  the  bills  with  their  acceptance.  Hence  all  the 
British  importers  need  ordinarily  do,  when  arranging  their  cotton 
purchases,  is  to  cable  the  American  vendors  the  names  of  the 
London  banks  they  are  to  draw  against  for  their  reimbursement. 

The  Letter  of  Credit. — But  where  an  American  exporter  has 
no  such  recognized  standing  among  American  banks  that  custom- 
arily purchase  commercial  bills,  it  is  necessary  for  his  British 
customer  to  provide  him  with  some  documentary  evidence  to 
submit  to  the  bank  to  which  he  offers  his  bill,  as  proof  of  the 
London  bank's  willingness  to  accept  the  bill.  This  evidence  is 
in  the  form  of  what  is  known  as  a  *' letter  of  credit,"  issued  by 
the  London  bank  to  its  client  and  forwarded  by  him  to  his  Ameri- 
can seller,  whom  it  formally  authorizes  to  draw  on  the  London 
bank  for  the  amount  and  in  accordance  with  the  terms  specified. 


LONG  STERLING  BILLS  137 

Upon  receiving  the  document,  the  exporter  exhibits  it  to  the  bank 
to  which  he  offers  his  bill  and,  if  his  credit  is  otherwise  satis- 
factory, he  experiences  little  difficulty  in  negotiating  the  bill.  If 
the  London  bank  pledges  itself  absolutely  in  the  credit  instru- 
ment to  accept  whatever  bills  are  drawn  up  to  the  amount  and  '^ 
in  conformity  with  the  conditions  specified,  the  credit  is  known  ^^  * 
as  a  '' confirmed"  or  ** irrevocable  credit."  If  the  London  bank 
reserves  the  right  to  cancel  at  any  time  it  sees  fit  whatever  portion 
of  the  credit  is  still  unused,  the  credit  is  called  an  "unconfirmed" 
or  ''revocable  credit."  Where  speed  is  desired  in  transmitting 
the  authorization  to  draw  the  bill  to  the  American  exporter, 
the  London  bank  cables  its  American  correspondent  to  issue  him 
a  letter  of  credit  in  its  behalf. 

It  is  generally  stipulated  in  connection  with  cotton  exports 
that  the  American  shipper  shall  defray  the  freight  charge  and 
the  marine  insurance  premium  on  the  shipment;  that  is,  the 
usual  conditions  of  sales  are  "c.i.f.,"  which  letters  are  abbrevia- 
tions of  the  words  "cost,  insurance,  and  freight."  The  American 
merchant,  however,  recoups  himself  for  these  shipping  expenses 
in  the  price  in  London  gold  he  charges  for  the  cotton.  He  fixes 
a  price  for  the  staple  that  will  yield  him,  upon  the  sale  of  the 
6o-day  bill,  an  amount  of  New  York  funds  sufficient  to  cover  all 
his  costs  and  leave  a  satisfactory  profit  in  his  hands. 

Computing  the  Price  of  a  Long  Commercial  Bill. — Coming 
now  to  our  illustration,  let  us  take  the  instance  of  a  cotton  ship- 
ment consigned  by  a  New  York  merchant  to  a  Liverpool  cotton- 
dealer.  Suppose  the  conditions  of  sale  are  precisely  as  they 
have  been  stated  above,  the  vendor  agreeing  to  draw  a  6o-day 
sight  draft  on  a  prime  London  bank  for  the  cost  of  the  shipment 
delivered  in  Liverpool,  which  we  shall  assume  to  be  £10,000. 
As  soon  as  he  has  effected  the  marine  insurance  and  delivered 
the  bales  to  the  transportation  company,  he  draws  a  draft  for 
the  amount  in  duplicate,  and  attaches  to  each  a  copy  of  the  bill 


138  FOREIGN  EXCHANGE 

of  lading,  insurance  certificate,  and  invoice.  As  he  makes  out 
the  draft  and  shipping  documents  to  his  own  order,  he  proceeds 
to  dispose  of  the  draft  in  the  open  market,  to  the  bank  bidding 
the  highest  price  for  it. 

Commercial  and  Bankers'  Bills  Compared. — This  brings  us 
to  the  manner  in  which  banks  compute  the  price  they  will  pay 
for  long  commercial  drafts.  In  another  chapter  (see  page  99) 
it  was  shown  that  long  bills  tend  to  parity  with  demand  bills  of 
the  corresponding  class  in  respect  to  the  credit  standing  of  the 
drawers,  and  that  this  parity  price  was  equal  to  the  price  of  the 
demand  bills  discounted  for  the  period  the  long  bills  ran  after 
sight  at  a  rate  representing  the  sum  of  the  London  discount 
rate  "to  arrive"  and  the  British  bill  stamp  rate.  Theoretically, 
/  then,  long  commercial  bills  should  tend  to  parity  with  demand 
commercial  bills  put  out  by  drawers  of  the  same  grade  of  credit 
as  the  drawers  of  the  long  bills.  In  actual  practice,  however, 
"^no  definite  tendency  of  the  sort  is  clearly  observable,  for,  to 
begin  with,  dealings  in  demand  commercial  bills  are  too  restricted 
in  volume  to  permit  of  a  regular  market  quotation  for  the  drafts; 
and,  in  the  second  place,  commercial  drawers  do  not  have  the 
facilities  possessed  by  banks  for  discounting  their  long  bills  in 
London  and  selling  their  own  demand  exchange  against  the 
proceeds.  Thus,  these  commercial  drawers  have  no  alternative 
-  but  to  dispose  of  their  long  bills  to  American  banks  at  the  best 
price  they  can  get,  regardless  of  the  relation  of  that  price  to  the 
parity  rate.  Because  of  this,  banks,  in  arriving  at  the  price  they 
will  pay  for  long  commercial  bills,  base  their  calculation  on  their 
own  prime  demand  bills,  which  have  a  constant  market  quotation. 
They  first  compute  the  parity  rate  of  the  long  commercial  drafts 
as  if  they  were  prime  bankers'  bills,  and  then  subtract  from  that 
rate  an  amount  which  measures  in  each  case  the  relative  inferior- 
ity of  the  drawer's  credit.  The  amount  deducted  in  the  case  of 
bills  of  a  particular  grade  of  credit  varies  to  a  certain  extent  with 


LONG  STERLING  BILLS  139 

the  demand  for  the  bills.  If  the  demand  for  long  bills  in  general 
is  strong,  the  purchasing  bank  may  have  to  forego  the  allowance 
entirely. 

Calculating  Price  of  Cotton  Bill. — To  calculate  the  price  of 
our  cotton  bill,  let  us  suppose  that  the  London  discount  rate  "  to 
arrive  "  on  the  draft  is  3%  per  annum,  and  the  price  for  prime 
bankers'  demand  drafts  is  $4,8650.  On  the  customary  basis 
of  365  days  to  the  year,  interest  on  the  demand  price  for  63 
days  (including  the  3  days  of  grace)  amounts  to  $.02519.  As 
the  British  bill  stamp  tax  is  actually  levied  at  the  rate  of  yo%  of 
the  face  amount,  this  percentage  of  the  demand  rate  amounts  to 
$.00243.  Hence  the  parity  rate  of  a  prime  banker's  60-day  bill 
is  the  demand  rate  of  $4.8650  minus  the  sum  of  the  above  in- 
terest and  stamp  tax,  or  $4.83738,  which  ordinarily  would 
be  given  as  $4.83!.  Assume  now  that  a  bank,  taking  into  ac- 
count the  cotton  exporter's  credit  and  the  existing  state  of  the 
market  for  long  bills,  bids  :i  of  a  cent  under  this  parity  rate,  or 
$4.83!^.  If  its  bid  is  accepted,  it  pays  the  exporter  a  total  of 
$48,350  for  the  £10,000  cotton  bill.  That  is  to  say,  for 
approximately  2,354  ounces  of  London  funds  payable  63 
days  after  the  acceptance  of  the  biU,  minus  1.2  ounces  for 
the  bill  stamp,  the  exporter  receives  immediately  2,339  ounces 
of  New  York  funds.  ^ 


^  For  the  convenience  of  banks  in  computing  the  parity  price  of  prime  long 
bills  of  the  ordinary  maturities,  a  so-called  interest  table  is  compiled,  which 
gives  at  a  glance  the  amount  to  be  deducted  from  the  prevailing  demand  price 
for  London  interest  and  the  bill  stamp.  The  amount  of  this  aggregate  dis- 
count is  figured,  however,  on  the  basis  of  a  constant  demand  price  of  ^4.85, 
as  it  is  obviously  impossible  to  construct  a  single  table  which  would  take  into 
account  a  varying  demand  price.  The  result  obtained  by  using  the  table  is, 
therefore,  slightly  different  from  that  secured  by  separate  calculation  on  the 
basis  of  the  prevailing  demand  rate.  It  will  be  observed  that  while  in  theory 
the  difference  between  the  parity  rates  for  demand  exchange  and  a  long  bill 
represents  interest  on  the  rate  for  the  latter,  in  practice  it  represents  interest 
on  the  demand  rate. 


HO  FOREIGN  EXCHANGE 

Procedure  of  Purchasing  Bank. — Receiving  the  two  copies 
of  the  draft  and  the  accompanying  documents,  the  purchasing 
bank  dispatches  them  by  the  next  two  mail  steamships  to  its 
London  correspondent,  with  instructions  to  obtain  acceptance 
from  the  drawee  bank,  and  to  discount  the  bill  immediately. 
Upon  the  arrival  of  the  first  of  exchange,  the  London  corre- 
spondent presents  it  to  the  drawee,  which  affixes  its  acceptance, 
having  first  satisfied  itself  that  both  bill  and  shipping  docu- 
ments comply  strictly  with  the  terms  of  the  credit  under 
which  the  bill  was  drawn.  On  returning  the  draft,  the  ac- 
cepting bank  retains  the  shipping  papers,  as  that  is  usually  one 
of  the  conditions  under  which  London  banks  agree  to  accept 
drafts   for  British   importers.     It   releases    the   bill   of   lading 

V  to  the  importer  on  whatever  terms  are  stipulated  in  their 
agreement.  Unless  he  enjoys  first-class  credit,  the  importer  will 
be  obliged  to  execute  a  trust  receipt  in  favor  of  the  bank,  by 
virtue  of  which  the  bank  will  have  full  control  of  the  cotton  con- 
signment after  its  arrival  in  Liverpool,  or  the  proceeds  from  its 
subsequent  sale,  until  it  is  reimbursed  for  the  face  amount  of 
the  draft  and  the  acceptance  commission. 

Upon  getting  back  the  accepted  draft,  the  London  corre- 

y  spondent  of  the  American  bank  attaches  the  bill  stamp  and  de- 
livers the  bill  to  the  discount  company  or  bill  broker  named  in  the 
New  York  bank's  letter  of  advice  as  having  agreed  to  discount 
it  at  the  annual  rate  of  3%.  The  £9,949  it  receives,  less  the  £5 
it  has  paid  out  for  the  bill  stamp,  it  passes  to  the  credit  of  the 
New  York  bank's  account,  against  which  it  charges  the  £9,944 
of  demand  bills  which  the  New  York  bank  presumably  sold 
when  it  purchased  the  long  bill  and  which  are  now  presented  for 
payment.  If  the  demand  bills  were  sold  at  an  average  rate  of 
$4.8650,  the  New  York  bank  received  approximately  $48,377 
for  their  entire  amount;  and  as  it  paid  $48,350  for  the  cotton 
bill,  it  netted  a  profit  of  $27.  Upon  the  maturity  of  the  cotton 
bill  the  holder  presents  it  to  the  accepting  bank  for  payment, 


LONG  STERLING  BILLS  14I 

and  receives  the  full  amount  of  £10,000  provided  in  advance  by 
the  importer. 

Documentary  Acceptance  Bills. — Varied  as  they  are  to  meet 
the  diverse  conditions  surrounding  the  export  shipments  giving 
rise  to  them,  commercial  bills  can  nevertheless  be  classified  into 
the  following  three  main  divisions: 

1.  Bills  accompanied  by  shipping  documents  which  are  re- 

leased when  the  bills  are  accepted. 

2.  Bills  accompanied  by  shipping  documents  which  are  not 

released  until  the  bills  are  paid. 

3.  Bills  not  accompanied  by  shipping  documents. 

These  classes  are  designated  as  follows: 

1 .  The  documentary  acceptance  bill.  ^ 

2.  The  documentary  payment  bill. 

3.  The  clean  bill. 

The  cotton  bill  just  described  illustrates  the  documentary 
acceptance  class.  The  holder  of  this  type  of  draft  releases  the 
bill  of  lading  and  the  other  shipping  documents  to  the  drawee 
when  the  draft  is  accepted,  and  thereafter  he  and  the  succeeding 
holders  have  only  the  unsecured  credit  of  the  acceptor  and  the  con- 
tingent liability  of  drawer  and  subsequent  indorsers  to  protect 
them  against  default  of  payment.  Generally  speaking,  bills  of  this 
class  are  drawn  on  prime  London  banks  and  private  bankers, 
whose  mere  acceptance  is  universally  taken  as  a  sufficient  guar- 
antee of  payment  to  render  the  bills  discountable  in  the  London 
bill  market  at  the  lowest  prevailing  rate. 

The  "  Domiciled  "  Bill. — There  is  a  species  of  documentary 
acceptance  drafts,   known  as  the   ''domiciled"   bill,   which  is 
drawn  on  a  foreign,  non-British  bank,  but  is  made  out  in  sterlingv 
and  is  payable  at  that  bank's  London  correspondent.     Thus, 
for  example,  against  a  shipment  to  Italy  the  American  exporter 


142  FOREIGN  EXCHANGE 

may  draw  for  the  requisite  amount  of  sterling  on  a  bank  in  Milan. 
The  New  York  bank  which  purchases  the  draft  forwards  it  first 
to  Milan  for  acceptance,  and  then  has  it  reforwarded  from  there 
to  London  for  discount,  or  for  payment  at  maturity.  Several 
days  prior  to  the  due  date  the  Italian  bank  remits  the  necessary 
amount  of  sterling  cover  to  its  London  correspondent,  with  in- 
structions to  pay  the  bill  upon  presentation.  The  cost  of  the 
remittance  it  charges  to  the  Italian  importer. 

Of  all  documentary  acceptance  bills  drawn  on  banks  the 
H   domiciled  draft  sells  at  the  lowest  price  in  New  York,  for  the 
following  reasons: 

1.  The  London  discount  market  harbors  a  decided  preju- 

dice against  foreign  acceptances,  and  exacts  a  higher 
discount  rate  on  them  than  on  bills  bearing  a  British 
bank  acceptance. 

2.  Allowance  must  be  made  in  the  price  of  the  bill  for  two 

bill  stamps,  one  affixed  in  the  country  of  acceptance 
and  the  other  in  London. 

3.  As  the  bill  travels  to  London  by  way  of  the  point  of 

acceptance,  its  price  is  not  figured  on  the  basis  of 
the  rate  for  demand  bills  sent  directly  to  London, 
but  on  the  basis  of  the  lower  rate  applying  to  demand 
bills  remitted  by  the  same  indirect  route  (see  page  102). 

Partly  because  of  these  disadvantages  attaching  to  the 
domiciled  bill,  some  foreign  banks,  in  their  eagerness  to  retain 
the  financing  of  native  imports  by  means  of  sterling  bills,  have 
established  branches  in  London  for  the  purpose  of  giving  their 
bills  the  status  of  London  acceptances.  But  London  bill  buyers 
show  some  discrimination  even  against  the  sterling  bills  of  these 
foreign  agencies.  As  a  rule  they  reserve  the  lowest  discount 
rate  for  bills  of  purely  British  acceptors,  the  great  joint-stock 
banks  and  the  world-renowned  private  banking  firms,  whose 
business  is  primarily  that  of  accepting  bills. 


LONG  STERLING  BILLS  I43 

The  Documentary  Payment  Bill. — Documentary  payment 
bills,  comprising  the  second  class  of  long  commercial  bills, 
resemble  the  documentary  acceptance  type  in  that  they  carry 
bills  of  lading  and  other  shipping  documents.  But,  unlike  the  . 
latter,  which  are  almost  always  drawn  on  banks,  they  are  made  ^ 
out  directly  on  the  overseas  importers,  and  as  the  unsupported 
credit  of  these  drawees  is  not  regarded  as  an  entirely  satisfactory 
guarantee  of  payment,  the  bills  of  lading  are  not  surrendered  to 
them  until  they  have  paid  the  drafts. 

By  the  custom  of  the  London  market,  however,  British 
importers  are  generally  allowed  the  option  of  anticipating  pay-  "^ 
ment  on  bills  of  this  class,  whenever  they  desire  to  get  possession 
of  the  underlying  shipments.  They  may  want  the  goods  in  ad- 
vance of  the  bill's  maturity  for  the  purpose  of  making  delivery 
on  a  sale  they  have  made,  or  to  save  warehouse  charges;  or,  if 
the  goods  are  of  a  perishable  nature,  to  make  better  provision 
for  their  preservation.  Whenever  they  avail  themselves  of  this 
privilege,  the  importers  are  allowed  a  rebate  from  the  face  amount 
of  the  draft  for  the  unexpired  portion  of  the  term,  which  is 
reckoned  at  |%  above  the  rate  of  interest  the  London  joint- 
stock  banks  are  granting  on  deposits,  commonly  referred  to  as 
the  "retirement  rate."  It  is  on  the  basis  of  this  rate  that  the 
bills  are  bought  by  New  York  banks. 

Naturally,  the  foreign  importers  must  know  where  to  look 
for  such  drafts  when  they  are  ready  to  take  them  up.  For  this  / 
reason  documentary  payment  bills  purchased  by  American  banks 
are  not  discounted  in  the  London  market,  but  are  held  until 
retired  by  the  importers.  It  is,  therefore,  impossible  for  Ameri- 
can banks,  in  order  to  secure  the  immediate  return  of  their  pur- 
chase money,  to  sell  demand  exchange  against  this  class  of  bills. 
If  they  desire  to  avoid  assuming  any  speculative  position  in  ex- 
change, they  may  sell  future  exchange  for  delivery  when,  as  they 
know  from  past  experience,  the  bills  are  likely  to  be  taken  up, 
provided  they  have  an  abundance  of  capital  at  their  disposal. 


144  FOREIGN  EXCHANGE 

Otherwise  they  reimburse  themselves  immediately  by  selling 
their  own  long  bills  on  their  London  correspondents  against  the 
pledge  of  the  payments  bills  as  collateral. 

Clean  Commercial  Bills. — Clean  bills,  the  third  class  of  com- 
mercial drafts,  are,  as  their  name  implies,  distinguished  by  the 
fact  that  they  are  not  accompanied  by  any  shipping  documents, 
these  documents  being  sent  by  American  exporters  directly  to 
their  customers.  American  banks  purchasing  bills  of  this  char- 
acter do  so  solely  on  the  strength  of  the  general  credit  of  the 
exporters  until  the  drafts  are  accepted  on  the  other  side.  Con- 
sequently, only  exporters  of  the  highest  credit  rating  can  draw 
clean  bills  with  any  expectation  of  being  able  to  sell  them  in 
New  York. 

Sterling  Import  Credit. — Having  discussed  long  commercial 
bills,  as  pertaining  to  the  sterling  export  credit,  the  medium  used 
in  financing  a  large  part  of  the  American  export  commerce,  we 
may  take  up  the  sterling  import  credit,  employed  in  financing 
imports.  The  procedure  here  is  precisely  the  reverse  of  that 
followed  in  the  case  of  the  export  credit.  In  making  a  purchase 
abroad,  the  American  merchant  applies  to  his  bank  to  open  for 
his  account  an  acceptance  credit  with  its  London  correspondent, 
in  favor  of  the  overseas  seller,  located,  let  us  say,  in  Milan,  Italy. 
In  complying  with  his  request,  the  bank,  which  has  a  standing 
arrangement  with  its  London  correspondent  on  the  matter  of 
acceptance  credits,  issues  him  a  letter  of  credit,  which  he  forwards 
to  the  Italian  merchant.  Upon  receiving  it,  the  latter  makes 
his  shipment  and  draws  a  draft  for  the  invoice  value,  against 
the  London  bank  named  in  the  credit.  He  negotiates  this  draft 
at  a  local  bank,  submitting  the  letter  of  credit  as  evidence  of  his 
authority  to  draw  on  the  London  bank.  The  draft  with  the 
attached  documents  is  sent  by  the  Italian  bank  to  its  London 
correspondent,  with  instructions  to  procure  its  acceptance,  and 


LONG  STERLING  BILLS  145 

then  either  to  discount  it  or  to  hold  it  pending  the  receipt  of 
further  orders.  In  the  meantime  the  London  drawee  is  advised 
by  the  New  York  bank  concerning  the  credit  that  has  been  issued 
against  it.  When  the  draft  is  presented  at  its  counter,  the  Lon- 
don bank  carefully  examines  the  documents,  and  if  it  finds  that 
they  conform  in  all  particulars  to  the  conditions  of  the  credit, 
it  accepts  and  returns  the  draft,  first  detaching  the  documents, 
which  it  relays  to  the  New  York  bank  for  release  to  the  importer 
under  a  trust  receipt,  or  on  any  other  terms  that  have  been 
agreed  upon. 

In  extending  a  reimbursement  credit,  the  New  York  bank  and 
the  London  acceptor  may  operate  on  a  joint-account  basis,  and 
share  together  whatever  profit  accrues  from  the  transaction. 
In  any  case,  the  New  York  institution  engages  to  furnish  the 
London  bank  with  the  required  amount  of  London  funds  to 
protect  the  draft  at  maturity,  but  holds  the  importer  in  turn 
responsible  for  the  amount  of  the  reimbursement.  Fifteen  days 
or  so  prior  to  the  draft's  maturity,  the  New  York  bank  expects  to 
receive  from  the  importer  either  a  demand  bill  for  the  amount, 
or  the  equivalent  in  New  York  funds  as  determined  by  the 
current  quotation  for  the  exchange.  For  the  service  of  secur- 
ing the  London  credit  and  guaranteeing  the  London  accepting 
bank  reimbursement,  the  New  York  bank  gets  a  commission 
from  its  client,  a  portion  of  which  it  passes  to  its  London  corre- 
spondent as  its  compensation  for  accepting  the  bill. 

If  the  importer  has  sold  the  merchandise,  or  is  in  funds  from 
other  sources  before  he  is  required  to  provide  his  bank  with  the 
sterling  reimbursement,  he  may  be  permitted  to  anticipate  pay- 
ment, in  which  event  he  is  granted  a  rebate  for  the  balance  of  the 
bill's  life  at  the  retirement  rate  of  discount  applying  to  documen- 
tary payment  bills.  Or  if  he  finds  it  more  advantageous,  he 
may  purchase  a  long  banker's  bill  on  London  for  the  amount 
of  the  required  remittance,  maturing  about  the  time  the  reim- 
bursement is  due  in  London,  and  hand  it  over  to  his  bank  in  full 


146  FOREIGN  EXCHANGE 

discharge  of  his  obligation.  In  the  event  of  his  inability  to 
furnish  the  remittance  when  due,  the  bank  may  allow  him  an 
extension  of  time,  for  which  it  will  charge  him  the  rate  commonly 
levied  on  London  bank  overdrafts,  which  is  1%  above  the 
oflacial  Bank  of  England  discount  rate. 

Dollar  Export  and  Import  Credits. — Prior  to  the  outbreak  of 
the  war  the  foreign  trade  of  the  United  States  was  financed 
almost  entirely  by  credits  established  in  foreign  centers,  chiefly 
in  London.  American  merchants  engaged  in  international 
commerce  were  compelled,  with  comparatively  few  exceptions, 
to  undertake  in  connection  with  every  transaction  the  exchange 
of  American  funds  for  foreign  funds,  or  the  reverse.  But  in  the 
field  of  international  finance  one  of  the  radical  changes  brought 
about  by  the  conflict  has  been  the  greater  resort  to  dollar  credits 
issued  by  American  banks — New  York  institutions  in  particular. 
This  tendency  in  no  small  measure  has  shifted  onto  overseas 
merchants  the  necessity  of  exchanging  foreign  for  American 
funds. 

\  This  increasing  use  of  dollar  credits  is  ascribable  to  several 
causes.  Shortly  before  the  world  was  engulfed  in  the  great 
cataclysm,  the  federal  government  enacted  the  Federal  Reserve 

'  Act,  authorizing  national  banks,  by  one  of  its  provisions,  to  accept 
bills  drawn  against  them  for  commercial  purposes.  This  enact- 
Vment  was  soon  followed  by  the  passage  of  laws  in  various  states 
conferring  a  similar  power  upon  banking  institutions  operating 
within  their  jurisdictions.  So  far  as  the  law  was  concerned, 
American  banks  were  prepared  to  advance  export  and  import 
merchants  in  the  United  States,  as  well  as  in  foreign  neutral 
countries,  the  accommodation  the  war  deprived  them  of  in 
London  and  other  belligerent  centers.  Simultaneously  with 
these  developments,  and  mainly  in  consequence  of  them,  there 

^grew  up  in  this  country  a  fairly  active  discount  market,  with  its 
center  in  New  York,  which  has  provided  foreign  banks  with  a 


LONG  STERLING  BILLvS  147 

ready  outlet  for  the  dollar  bills  they  purchase  of  their  exporting 
customers,  and  has  accordingly  encouraged  them  in  the  use  of 
dollar  credits. 

Brief  Analysis  of  Dollar  Credits. — No  extended  analysis  of 
dollar  credits  is  necessary  here,  as  their  issuance  by  American 
banks  is  precisely  analogous  to  the  advance  of  sterling  credits 
made  by  London  banks.  In  the  case  of  exports,  let  us  say,  to 
Buenos  Aires,  the  Argentine  importer  requests  his  local  bank 
to  open  a  credit  with  a  New  York  bank  for  the  benefit  of  the 
American  exporter.  Upon  receiving  the  authorization  to  draw 
against  the  New  York  bank,  either  by  letter  of  credit  issued  by  the 
Buenos  Aires  bank  and  transmitted  by  the  Argentine  customer, 
or  by  letter  of  advice  from  the  New  York  bank,  the  American 
exporter  draws  a  draft  for  the  invoice  amount  of  the  shipment, 
and,  attaching  the  bill  of  lading  and  other  documents,  secures 
the  New  York  bank's  acceptance  of  it.  Thereupon  he  disposes 
of  the  draft  in  New  York  to  an  acceptance  dealer  or  his  own 
bank,  and  thus  obtains  immediate  reimbursement  against  his 
consignment.  The  draft  being  supposedly  of  the  documentary 
acceptance  variety,  the  New  York  accepting  bank  keeps  the  bill 
of  lading  and  forwards  it  to  the  Buenos  Aires  bank  for  release  to 
its  client.  With  the  approach  of  the  draft's  maturity  date,  the 
Argentine  importer  purchases  demand  exchange  on  New  York 
for  its  face  amount,  and  turns  it  over  to  his  bank,  which  remits 
the  exchange  to  the  New  York  accepting  bank.  Being  thus  put 
in  funds  the  New  York  bank  meets  the  long  draft  as  it  comes  due, 
and  brings  the  entire  transaction  to  a  close. 

As  for  the  financing  of  imports  with  dollar  credits,  the  Ameri- 
can importer  arranges  with  a  New  York  bank  for  an  acceptance 
credit  in  favor  of  an  Argentine  exporting  merchant,  who  upon 
being  notified  of  the  fact  makes  his  shipment  and  draws  his  bill 
in  dollars  against  the  New  York  bank.  He  sells  this  bill  to  a 
Buenos  Aires  bank  for  domestic  funds  at  the  prevailing  rate 


148  FOREIGN  EXCHANGE 

for  dollar  exchange.  The  purchasing  bank  forwards  the  bill 
at  once  to  its  New  York  correspondent  for  acceptance  and  dis- 
count, and  at  the  same  time  presumably  offsets  the  purchase 
with  the  sale  of  its  own  demand  exchange  on  New  York.  Upon 
the  arrival  of  the  long  bill  in  New  York,  the  drawee  bank  accepts 
it  and  withholds  the  bill  of  lading,  for  the  purpose  of  turning 
it  over  to  the  importer.  Getting  back  the  accepted  bill,  the 
New  York  correspondent  of  the  Buenos  Aires  bank  has  the  bill 
discounted,  and  with  the  proceeds  meets  the  demand  bills  the 
Argentine  bank  has  sold.  Subsequently,  when  the  long  bill 
matures,  it  is  retired  by  the  accepting  bank  with  funds  supplied 
in  advance  by  the  American  importer. 

Long  Bankers'  Sterling  Bills. — Long  sterling  bills  that  are  used 
in  contracting  short-time  loans  in  the  open  discount  market  in 
London,  being  generally  issued  by  banks  and  bankers,  are  given 
the  name  of  "bankers'  bills"  (see  Chapter  VI,  page  96).  The 
drafts  are  drawn  on  the  London  correspondents  of  the  New  York 
banks,  usually  for  60  or  90  days'  sight,  and  are  either  sold  in 
London  over  against  a  sale  of  demand  exchange  (or  cables), 
or  are  marketed  in  New  York.  They  are  disposed  of  in  the 
latter  place  at  prices  which  vary  with  the  financial  strength  of 
their  respective  drawers  and  acceptors.  Those  bearing  prime 
names  command  the  best  prices,  and  tend  to  parity  with  the 
corresponding  grade  of  demand  bills  in  respect  to  the  standing 
of  the  drawers.  Hence  their  parity  price  is  equal  to  the  price 
for  prime  bankers'  demand  drafts,  the  regularly  quoted  demand 
rate,  discounted  for  the  period  they  run  after  sight  at  a  rate 
equal  to  the  sum  of  their  London  discount  rate  ''to  arrive"  and 
the  British  bill  stamp  rate.  Other  bills,  issued  by  banks  of  infe- 
rior standing,  sell  for  lower  prices,  which  are  arrived  at  in  the 
manner  indicated  in  the  case  of  long  commercial  drafts  (see 
page  139). 

One  of  the  purposes  for  which  New  York  banks  put  out  their 


LONG  STERLING  BILLS  I49 

long  bills  is  to  prevent  their  funds  from  being  locked  up  for  any  y 
period  of  time  in  the  non-discountable  commercial  drafts  they 
purchase,  and  incidentally  to  avoid  the  risk  of  a  possible  drop  in 
exchange  rates  pending  the  maturity  of  the  commercial  drafts. 
As  the  bills  are  drawn  for  the  same  period  of  time  as  the  com- 
mercial drafts,  they  offset  the  latter  at  maturity,  and  the  neces- 
sity of  retransferring  funds  to  New  York  by  the  sale  of  demand 
or  cable  exchange  is  obviated.  The  sale  of  long  bankers'  bills 
against  the  purchase  of  commercial  drafts  represents  but  a  quick 
turnover  of  exchange,  and  banks  can,  therefore,  issue  them  the 
year  round  as  a  part  of  their  regular  exchange  business,  regardless 
of  the  future  movement  of  spot  exchange  rates  or  the  present 
position  of  future  rates.  Or  viewed  from  another  standpoint, 
the  sale  of  long  bankers'  bills  against  the  purchase  of  commercial 
drafts  merely  amounts  to  borrowing  in  the  London  discount  ^ 
market  against  loans  advanced  in  London  at  a  higher  rate  to 
foreign  importers. 

Bills  Issued  for  Relending. — We  are  chiefly  interested,  how- 
ever, in  long  bankers'  bills  that  are  put  out  for  the  purpose  of  t^ 
relending  the  proceeds  in  New  York,  and  against  the  maturity 
of  which  remittance  must  be  made  to  London.  As  the  money 
thus  realized  is  usually  employed  in  what  are  known  as  "financial 
transactions,"  that  is,  in  the  purchase  of  securities,  the  drafts  in 
this  case  are  referred  to  as  ''finance  bills."  They  are  put  out  . 
only  when  the  cost  incident  to  their  issue  is  less  than  the  interest 
on  loans  contracted  in  New  York.  The  amount  of  this  cost 
depends  in  every  case  on  the  relation  of  the  price  that  will  be 
paid  for  demand  or  cable  exchange  when  cover  is  remitted  to 
the  London  acceptor,  to  the  price  secured  for  the  long  bill.  In 
figuring  the  relative  advantage  of  floating  their  long  bills,  banks 
must  take  into  account  either  the  current  rate  for  future  demand 
or  cable  exchange,  or  the  probable  course  of  the  spot  rates  for 
the  same  exchanges  during  the  life  of  the  long  bills. 


150  FOREIGN  EXCHANGE 

Issue  of  a  Finance  Bill. — As  an  illustration  of  the  issue  of  a 
finance  bill,  let  us  take  the  instance  of  a  90-day  sight  bill  for 
£10,000  drawn  by  a  prime  New  York  bank  upon  its  London 
correspondent,  which  charges  the  bank  an  acceptance  commis- 
sion of  1%  of  the  face  amount.  Suppose  a  rate  "to  arrive"  of 
4i%  is  quoted  for  the  bill  in  London,  as  against  an  interest  rate 
of  5i%  ruling  in  New  York  on  loans  of  equal  maturity;  and 
suppose  the  price  for  demand  exchange  prevailing  at  the  moment 
is  $4.87.  By  referring  to  the  interest  table  customarily  used  by 
bankers  in  calculating  the  price  of  long  bills  (see  footnote,  page 
139),  we  find  the  parity  price  for  the  draft  in  question  to  be 
$4.8150,  or  the  demand  rate  of  $4.87  less  the  following  two 
items — interest  at  the  rate  of  4^%  for  93  days,  and  the  stamp 
tax  of  ^\% — which,  as  given  in  the  table,  together  amount  to 
$.0550. 

Suppose  the  bank  happens  to  sell  the  bill  precisely  at  this 
parity  price,  or  for  a  total  of  $48,150;  and  at  the  same  time 
purchases,  at  the  rate  of  $4.8625,  cover  for  the  amount  of  the 
long  bill  and  acceptance  commission  in  the  shape  of  future  de- 
mand exchange  for  £10,012.5,  deliverable  93  days  later.  As  its 
outlay  on  the  future  contract  will  amount  to  $48,685.78,  the  93 
days'  loan  of  $48,150  will  cost  it  $535.78  in  interest,  or  at  the 
annual  rate  of  approximately  4.36%.  In  view  of  the  5^%  inter- 
est rate  assumed  in  New  York,  it  advantages  the  bank  to  market 
its  long  bill  on  London  instead  of  borrowing  in  New  York. 

Assume  now  that  instead  of  purchasing  future  exchange,  the 
bank  elects  to  defer  providing  itself  with  cover  until  the  long  bill 
is  due,  being  persuaded  that  in  the  meantime  the  spot  demand 
rate  will  decline  below  the  present  quotation  of  $4.8625  for 
future  demand.  If  it  should  happen  to  be  correct  in  its  forecast, 
the  issue  of  the  bill  will  cost  it  less  in  interest  than  the  per  annum 
rate  of  4.36%.  On  the  other  hand,  if  its  calculations  should 
prove  to  be  wrong  and  the  spot  demand  rate  should  rise  above 
$4.8625  during  the  next  93  days,  the  interest  charge  on  its  long 


LONG  STERLING  BILLS  1 51 

bill  will  amount  to  more  than  4.36%,  and  might  even  exceed  the 
interest  rate  now  current  in  New  York. 

One-Name  and  Two-Name  Long  Bankers'  Bills. — Long 
bankers'  bills  are  classified  under  the  headings  of  "one-name" 
and  *'  two-name  "  bills.  The  one-name  variety,  or  "pig  on  pork," 
as  it  is  called  in  the  lingo  of  exchange  dealers,  embraces  bills 
drawn  by  banks  on  affiliated  concerns  in  London,  that  is,  bills 
drawn  by  trust  companies  and  foreign  bank  agencies  on  their 
London  branch  offices,  or  by  private  banking  firms  on  similar 
houses  in  London  controlled  by  the  same  interests.  The  drawer 
and  acceptor  being  virtually  identical  concerns,  such  bills  repre- 
sent but  a  single  financial  responsibility.  The  two-name  class 
includes  bills  the  drawers  and  acceptors  of  which  are  strictly 
separate  and  mutually  independent  establishments;  they  re- 
present a  twofold  security.  On  this  account  prime  two-name 
bills  always  command  a  lower  discount  rate  in  London  and  a 
higher  price  in  New  York  than  the  best  one-name  bills.  Never- 
theless, New  York  institutions  with  branches  in  London,  or 
private  bankers  with  affihated  houses  in  London,  invariably 
issue  their  one-name  bills,  since  the  loss  they  suffer  by  reason 
of  the  lower  price  at  which  they  sell  these  bills  is  more  than 
compensated  for  by  the  saving  in  acceptance  commission  they 
would  otherwise  be  obliged  to  pay. 

Issuers  of  one-name  bills  frequently  put  them  out  merely 
for  the  sake  of  the  acceptance  commission  they  thereby  obtain. 
In  lieu  of  selling  the  bills  themselves,  they  turn  them  over  to 
others  who  lack  the  requisite  facilities  for  drawing  on  London, 
and  receive  the  customary  fee  in  return.  Those  accommodated 
in  this  way  are  generally  large  stock  brokerage  houses  or  money 
brokers.  They  dispose  of  the  drafts  in  New  York,  and  either 
relend  or  utilize  the  proceeds  in  their  own  business.  They  pro- 
cure the  bills  only  upon  giving  satisfactory  guarantee  of  fur- 
nishing the  issuing  banks  with  the  exchange  the  latter  will  be 


u/ 


152  FOREIGN  EXCHANGE 

obliged  to  remit  to  London  as  cover  for  the  bills.  This  guarantee 
consists:  (i)  of  immediately  placing  in  the  hands  of  the  banks 
contracts  of  other  prime  institutions  promising  delivery  of  de- 
mand or  cable  exchange  when  the  long  bills  fall  due;  and  (2) 
of  engaging  to  supply  the  banks  with  the  funds  they  will  be  re- 
quired to  pay  on  the  future  contracts,  and  to  that  end  pledging 
with  them  stocks  and  bonds  as  collateral  security. 

Renewal  and  Swapping  of  Long  Bills. — Long  bankers*  bills 
are  often  renewed  once  or  several  times,  and  on  occasion  even 
indefinitely.  Upon  each  renewal,  the  new  bills  are  either  sold 
and  the  proceeds  devoted  to  the  purchase  of  demand  or  cable 
exchange  to  meet  the  old;  or  they  are  exchanged  directly,  that 
is  to  say,  swapped  for  demand  or  cable  exchange.  The  swap- 
ping operations  are  tantamount  to  the  discount  of  the  long  bills 
in  London,  and  are  arranged  on  the  basis  of  the  prevailing  rates 
for  the  long  bills  and  demand  or  cable  exchange.  The  amounts 
swapped  are  in  each  case  equal,  the  holder  of  the  long  bill  paying 
\^the  holder  of  the  demand  or  cable  exchange  the  difference  between 
the  two  prices,  which  represents  the  London  interest  and  bill 
stamp  converted  into  New  York  funds.  Thus,  for  example, 
if  a  £10,000  90-day  sight  bill  is  exchanged  for  the  same  amount 
of  demand  exchange  on  the  basis  of  $4.8090  for  the  long  bill  and 
$4.87  for  the  demand  draft,  the  owner  of  the  long  bill  pays  the 
owner  of  the  demand  draft  the  difference  between  the  two  rates 
for  every  £1  exchanged,  or  $610  on  the  entire  swap.  In  a  similar 
manner  swapping  operations  may  be  executed  between  bills  of 
different  maturity  selling  at  prices  representing  the  same  or 
different  per  annum  interest  yields,  or  between  bills  of  the  same 
maturity  which  are  quoted  at  varying  prices  because  of  the  differ- 
ing credit  standing  of  their  respective  drawers  and  drawees. 

Investment  Demand  for  Long  Bills. — Long  bills  of  either 
description,  bankers'  or  commercial,  are  purchased  by  banks 


LONG  STERLING  BILLS  153 

and  held  to  maturity  as  investments  when  conditions  are  favor- 
able. As  was  learned  in  an  earlier  chapter  (see  page  94),  the 
amount  of  interest  return  on  such  investments  is  determined 
by  the  price  at  which  demand  or  cable  exchange  is  sold  against 
their  maturity  as  compared  with  the  price  at  which  the  long  bills 
are  bought.  To  take  a  concrete  case,  suppose  a  bank  purchases 
a  60-day  sight  bill  for  £10,000  at  the  rate  of  $4.82,  and  at  the 
same  time  sells  at  the  rate  of  $4.8610  a  demand  future  for  £9,995 
(the  face  amount  of  the  long  bill  minus  the  bill  stamp  of  ^^%)j 
deliverable  in  63  days.  Against  the  $48,200  it  now  lays  out  on 
the  bill,  it  will  receive  $48,585.69.  It  will  net  a  return  of  $385.69 
on  its  63  days'  investment,  or  a  per  annum  rate  of  4.63%.  If, 
however,  it  postpones  the  sale  of  exchange  until  the  long  bill  is 
about  to  mature,  the  investment  will  net  it  a  yield  higher  or 
lower  than  the  above  rate,  according  as  the  price  at  which  it 
sells  the  exchange  will  be  greater  or  less  than  the  current  future 
rate  of  $4.8610. 

Date  Bills. — The  long  bills  we  have  thus  far  been  considermg 
are  more  specifically  referred  to  as  "long-sight  bills,"  in  allusion 
to  the  fact  that  they  are  payable  a  stated  number  of  days  or 
months  after  they  are  accepted  in  London.  Since  buyers  of  such 
bills  must  remit  them  to  London  for  acceptance  in  order  to  fix 
their  maturity  date,  it  is  impracticable  for  anyone  to  invest  in 
them  who  has  no  bank  correspondent  in  London  to  attend  to 
their  being  accepted.  On  occasion,  however,  when  the  rate  of 
return  on  long  bills  is  particularly  attractive,  issuing  banks  make 
it  possible  for  even  those  not  engaged  in  the  regular  foreign 
exchange  business  to  invest  in  the  bills,  by  putting  out  a  special 
type  known  as  ''date  bills." 

As  its  name  suggests,  this  type  of  draft  is  made  out  to  mature 
a  specified  period  after  it  is  drawn,  irrespective  of  when  it  will 
be  accepted  by  the  London  drawee.  Consequently,  a  buyer  of 
a  date  bill  need  not  be  in  any  haste  to  secure  its  acceptance,  if 


154  FOREIGN  EXCHANGE 

he  is  satisfied  with  the  drawer's  credit.  Indeed,  he  is  not  obliged 
to  remit  it  to  London  at  all,  if  he  decides  to  hold  it  until  it  is  time 
to  forward  it  across  for  collection,  for  he  can  then  sell  the  bill  as 
demand  exchange,  or  deliver  it  on  a  future  contract  he  may 
have  previously  put  out.  Furthermore,  if  he  sells  it  to  the  bank 
he  bought  it  from,  the  bill  will  be  canceled  on  this  side  and 
never  reach  London;  incidentally  he  will  save  himself  the  cost  of 
the  British  bill  stamp.  As  a  matter  of  fact,  issuers  of  date  bills 
allow  buyers  the  option  of  selling  the  bills  back  to  them  and 
^ ;  accepting  in  payment  demand  drafts,  which  they  can  dispose  of 
in  the  open  market. 

Date  bills  are  generally  drawn  to  run  for  70  or  100  days, 
in  order  that  their  maturity  may  approximate  the  due  dates  of 
60-  and  90-day  sight  bills  issued  at  the  same  time,  10  days  being 
allowed  for  the  sight  bills  to  reach  London  and  be  accepted.  A 
bank  may  thus  sell  its  70-day  date  bill  against  its  purchase  of 
a  60-day  sight  bill,  and  have  the  date  bill  itself,  or  the  demand 
bill  which  it  gives  in  payment  if  it  buys  back  the  date  bill,  met 
with  the  proceeds  from  the  collection  of  the  sight  bill.  Both' 
types  of  bills,  are,  therefore,  equivalent,  and  given  drawers  and 
drawees  of  equal  credit  standing,  sell  for  the  same  price.  In 
figuring  the  parity  price  of  a  date  bill,  account  is  taken  of  the 
extra  number  of  days  it  is  discounted  for,  by  basing  the  calcula- 
tion on  the  prevailing  spot  cable  price.  The  parity  quotation  is 
equal  to  the  cable  price  discounted  at  the  London  rate  of  inter- 
est and  bill  stamp  for  the  time  the  bill  runs  from  date. 

Intercity  Loans;  Other  Types. — Loans  negotiated  between 
New  York  and  London  have  heretofore  been  considered  solely 
with  reference  to  one  particular  type,  namely,  the  long  bill  of 
exchange.  Intercity  loans,  when  they  take  the  form  of  straight 
advances  on  promissory  notes,  or  bond  issues  floated  in  one 
country  by  corporations  of  the  other,  are  of  a  somewhat  different 
nature. 


LONG  STERLING  BILLS  155 

The  contract  by  which  a  loan  is  extended  by  a  party  in  the 
one  city  to  a  party  in  the  other  must  stipulate,  first,  where  the 
loan  is  to  be  advanced,  and  second,  where  the  interest  and  prin-  ^ 
cipal  are  to  be  paid.  That  is  to  say,  the  lender  and  borrower 
must  agree  upon  the  place  in  which  the  former  is  in  efifect  to 
deliver  the  gold  he  is  advancing,  and  also  upon  the  place  in  which 
the  borrower  is  to  tender  the  gold  he  will  give  in  payment  of  the 
interest  and  the  loan.  As  a  rule  the  contract  provides,  par- 
ticularly in  the  case  of  short-term  loans,  for  payment  of  the  prin- 
cipal and  interest  where  the  advance  is  made.  Thus,  if  an 
American  extends  a  loan  in  London,  he  usually  agrees  to  accept 
payment  in  that  city. 

The  Sterling  Loan. — Measured  as  it  is  in  terms  of  the  British 
monetary  unit,  an  intercity  loan  extended  in  London  is  known  as 
a  ^'sterhng  loan."  The  British  lender,  or  the  British  borrower, 
if  the  advance  is  made  by  an  American,  is  under  no  necessity 
of  performing  an  exchange  transaction  between  the  two  cities, 
either  when  the  loan  is  contracted  or  when  it  is  due.  The  one 
will  accordingly  receive  and  the  other  will  pay  the  rate  of  inter- 
est mentioned  in  the  contract,  and  from  the  standpoint  of  both 
the  loan  is  in  no  wise  different  from  a  domestic  loan. 

Quite  the  opposite,  however,  is  the  case  as  regards  the  Ameri- 
can lender  or  borrower  of  a  sterling  loan.  When  making  the 
advance,  the  former  must  first  place  himself  in  funds  in  London 
by  either  purchasing  sterling  exchange  in  New  York  or  selling 
dollar  exchange  in  London;  and  subsequently,  when  he  is  paid 
the  interest  and  principal  in  London,  he  must  either  sell  sterling 
exchange  in  New  York  or  purchase  dollar  exchange  in  London 
by  way  of  transferring  his  funds  back  to  New  York.  On  the 
other  hand,  if  the  American  party  to  a  sterling  loan  is  the  bor- 
rower, and  wants  to  utilize  the  proceeds  in  New  York,  he  is 
obliged  either  to  sell  sterling  exchange  in  New  York  or  buy  dollar 
exchange  in  London;  and  later,   when  interest  and  principal 


156  FOREIGN  EXCHANGE 

are  due,  he  is  required  to  remit  to  London  by  either  purchasing 
sterling  exchange  in  New  York  or  seUing  dollar  exchange  in 
London.  Thus,  in  the  case  of  a  sterling  loan,  the  American  lender 
or  borrower,  as  the  case  may  be,  must  perform  an  exchange  in 
(/the  one  direction  when  the  loan  is  advanced,  and  in  the  other 
direction  when  interest  and.  principal  are  due.  As  the  one  com- 
putes his  interest  return  and  the  other  his  interest  cost  in  terms 
of  New  York  funds,  the  interest  rate,  on  this  basis  of  calculation, 
will  differ  from  the  contract  rate  if  the  prices  at  which  the  two 
exchanges  are  effected  vary  from  each  other. 

Example  of  a  Sterling  Loan. — To  take  an  example,  suppose 
a  party  in  New  York  purchases  a  cable  transfer  on  London  for 
'  £i,ooo  at  the  rate  of  $4.86,  and  lends  the  sum  out  for  a  half- 
year  at  the  annual  rate  of  6%,  agreeing  to  accept  payment  in 
the  same  place.  He  thus  lays  out  $4,860  in  New  York  on  the 
loan,  upon  the  maturity  of  which  he  will  receive  £1,030  in  London. 
If  on  the  due  date  he  should  sell  against  this  amount  of  sterling 
cable  transfers  at  the  rate  of  $4.87,  he  will  have  $5,016.10  in 
New  York.  For  all  practical  purposes  he  may  be  regarded  as 
advancing  $4,860  and  being  paid  back  $5,016.10.  The  return  on 
his  loan  will,  therefore,  amount  to  $156.10,  or  at  the  annual  rate 
of  6.42%.  Thus  by  reason  of  the  appreciation  of  sterling  ex- 
change from  $4.86  to  $4.87  during  the  Hfe  of  the  loan,  he  will 
secure  a  per  annum  rate  of  return  .42%  in  excess  of  the  rate 
stipulated  in  the  contract.  If,  however,  the  sterling  rate  had 
declined  below  $4.86  during  the  6  months,  the  yield  on  the  loan 
would  have  been  less  than  the  contract  rate  of  6%. 

In  the  opposite  case,  where  a  sterling  loan  is  advanced  by 
a  Britisher  to  an  American,  the  interest  cost  to  the  latter  as 
computed  in  New  York  funds  will  be  less  than  the  contract  rate 
if  he  should  pay  a  lower  price  for  the  sterling  exchange  he  will 
remit  to  London  upon  the  maturity  of  the  loan,  than  the  price 
at  which  he  now  sells  exchange  against  the  proceeds  of  the  loan. 


LONG  STERLING  BILLS  157 

It  will  be  greater  than  the  contract  price,  if  he  should  pay  a 
higher  price  for  his  future  purchase  of  exchange  than  he  receives 
on  his  present  sale.  In  short,  an  advance  in  the  sterling  rate  of 
exchange  during  the  period  of  a  sterling  loan  is  favorable  to  an 
American  lender  of  such  a  loan  and  adverse  to  an  American  bor- 
rower, while  a  decline  in  the  rate  of  exchange  is  adverse  to  an 
American  lender  and  favorable  to  an  American  borrower.  The 
parties  to  the  loan  may  eliminate  this  speculative  element,  how- 
ever, by  respectively  selling  or  purchasing  in  the  beginning 
future  exchange  maturing  when  the  loan  falls  due.  By  this 
expedient  they  fix  in  advance  the  rate  of  interest  return  or  charge 
as  figured  in  New  York  funds. 

The  Dollar  Loan. — When  a  loan  between  the  two  cities  is 
advanced  in  New  York,  it  is  called  a  "dollar  loan."  Here  it  is 
the  American  lender  or  borrower,  as  the  case  may  be,  who  is 
not  obliged  to  undertake  any  exchange  operations.  Hence  the 
interest  rate  the  one  will  receive  and  the  other  will  pay  will  be 
precisely  the  rate  stipulated  in  the  contract.  On  the  other  hand, 
the  British  lender  of  a  dollar  loan  must  purchase  dollar  exchange 
in  London  (or  sell  sterling  exchange  in  New  York)  preliminary 
to  making  the  advance,  and  subsequently,  when  the  loan  is 
repaid,  sell  dollar  exchange  in  London  (or  purchase  sterling 
exchange  in  New  York) .  As  he  will  naturally  reckon  the  amount 
of  his  interest  yield  in  London  funds,  the  rate  of  return  will  be 
greater  than  the  contract  rate  if  the  price  of  dollar  exchange 
advances  during  the  currency  of  the  loan,  and  smaller  if  the 
price  of  exchange  decHnes.  As  for  the  British  borrower  of  a 
dollar  loan,  he  sells  dollar  exchange  in  London  (or  buys  sterling 
exchange  in  New  York)  at  the  outset  by  way  of  transferring  the 
proceeds  home;  and  later,  when  he  remits  to  New  York  to  meet 
the  maturing  loan,  he  will  purchase  dollar  exchange  in  London 
(or  sell  sterling  exchange  in  New  York).  It  is  obvious  that  the 
rate  of  interest  he  will  pay  in  London  funds  will  exceed  or  be 


/ 


ly' 


158  FOREIGN  EXCHANGE 

less  than  the  contract  rate  according  as  the  price  of  dollar  exchange 
rises  or  falls  in  the  meantime. 

Payment  of  International  Bond  Issues.— Like  domestic  ad- 
vances, international  loans  run  for  short  periods  or  for  a  number 
of  years.  In  the  latter  case  they  naturally  take  the  form  of  bond 
issues.  Even  here  it  is  generally  stipulated  that  the  bonds  and 
coupons  shall  be  payable  in  the  city  of  their  issue.  But  occa- 
sionally it  is  provided  that  they  shall  be  payable  in  either  city 
at  the  option  of  the  bondholders.  In  that  event  a  rate  is  fixed 
for  the  purpose  of  determining  the  amount  the  corporation  will 
be  obliged  to  pay  in  the  other  city.  Whether  the  bondholders 
will  present  their  claims  at  maturity  in  the  one  or  the  other  city 
will  depend  on  the  relative  position  this  fixed  rate  holds  to  the 
rate  of  exchange  prevailing  at  the  time,  as  the  following  example 
will  show. 

Suppose  an  American  corporation,  which  has  put  out  a  ster- 
ling issue  of  bonds  in  London,  has  accorded  holders  the  privilege 
of  demanding  payment  on  the  coupons  and  bonds  either  in 
London  for  the  full  face  amount  as  expressed  in  pounds  sterling, 
or  in  New  York  at  the  rate  of  $4.8665  per  £1  of  the  face  amount. 
If,  on  the  maturity  dates  of  the  coupons  and  bonds,  the  rate  for 
sterHng  cables  is  $4.85,  it  will  pay  American  holders  to  present 
them  for  payment  in  New  York,  as  their  receipts  will  be  less  by 
$.0165  per  £1  of  the  amount  due  if  they  should  accept  payment 
in  London  and  sell  sterHng  exchange  against  it.  It  will  Kkewise 
advantage  British  holders  to  remit  their  coupons  and  bonds  to 
New  York  for  payment  and  receive  $4.8665  per  £1  of  the  face 
amount,  as  by  purchasing  with  the  proceeds  sterling  exchange 
in  New  York  at  the  rate  of  $4.85,  they  will  net  £1  xffo^  ^^^  every 
£1  of  the  face  amount  of  their  claims.  On  the  other  hand,  if 
the  sterHng  rate  is  quoted  above  the  fixed  rate  of  $4.8665  when 
the  coupons  and  bonds  mature,  say  at  $4.88,  British  holders  wiU 
then  require  payment  in  London,  as  they  will  obtain  less  than 


LONG  STERLING  BILLS  159 

the  face  amount,  to  be  exact,  fjfff  of  £i  per  £i  of  interest  or 
principal,  if  they  should  accept  payment  in  New  York  and 
purchase  sterHng  exchange.  American  holders  will  also  demand 
payment  in  London,  since  by  selling  sterling  exchange  against 
the  proceeds  at  the  rate  of  $4.88,  they  will  receive  $4.88  for  every 
£1  of  the  amount  due,  as  against  $4.8665  if  they  should  request 
payment  in  New  York. 

The  bonds  must,  of  course,  be  remitted  to  the  foreign  city 
sufficiently  in  advance  to  permit  of  their  being  presented  on  the 
due  date.  Unless,  then,  the  holders  are  willing  to  run  the  risk 
of  a  decline  in  exchange  rates  while  the  securities  are  en  route, 
they  will  sell,  when  they  mail  the  securities,  either  spot  demand 
exchange,  or  future  cables  for  delivery  on  the  maturity  date  of 
the  bonds.  Moreover,  to  protect  themselves  against  the  loss  of 
the  securities,  they  will  take  out  marine  insurance,  the  charge 
on  which  in  peace  times  is  at  the  rate  of  about  ro%  oi  the  face 
amount  of  the  bonds.  They  must,  therefore,  make  due  allow- 
ance for  this  item  of  cost  in  figuring  the  relative  advantage  of 
receiving  payment  on  the  bonds  in  the  foreign  city.  Naturally, 
only  bankers  with  correspondents  in  the  foreign  city  can  remit 
such  bonds  and  coupons  for  collection  abroad.  Other  holders  are 
obliged  to  dispose  of  them  at  home  as  demand  exchange,  in  suffi- 
cient time  to  permit  the  purchasing  bankers  to  send  the  securi- 
ties to  the  other  side  for  presentment  on  the  day  of  maturity. 

Thus  where  bonds  issued  in  one  center  are  made  payable  as  to 
both  interest  and  principal  in  either  place  at  a  fixed  rate,  holders  y 
are  permitted  to  take  advantage  of  the  current  position  of  the 
exchange  rate  on  the  interest  and  maturity  dates  of  the  bonds. 
The  risk  inherent  in  the  course  of  the  exchange  rate  pending 
the  maturity  of  the  coupons  and  principal  is  undertaken  by  the 
corporation,  which  is  willing  to  shoulder  it  for  the  sake  of  ren- 
dering the  securities  more  attractive  to  investors  in  both  markets. 


CHAPTER  XI 

OTHER  FOREIGN  EXCHANGES  IN  NEW  YORK 

Settlements  between  Various  Countries. — Exchange  on 
London  is  employed  extensively  in  making  international  settle- 
ments the  world  over;  that  is,  a  great  proportion  of  the  payments 
between  the  various  countries  are  effected  by  what  is  tantamount 
to  the  delivery  of  gold  in  London,  namely,  the  transfer  of  London 
bank  deposits,  or  claims  on  London  banks  for  ready  gold.  Owned 
by  banks  hailing  from  every  quarter  of  the  globe,  these  bank 
balances  are  drawn  against,  by  cable  transfer,  demand  and  long 
drafts,  in  favor  of  customers  who  require  sterling  exchange  to 
pay  obligations  in  other  countries,  and  are  at  the  same  time 
replenished  as  the  banks  purchase  sterhng  exchange  from  other 
customers  who  have  received  it  from  their  foreign  debtors. 

To  all  intents  and  purposes,  then,  London  banks  constitute 
one  great  storehouse  of  gold,  held  for  account  of  foreign  deposit- 
ing banks,  by  whose  intervention  it  serves  as  the  medium  of 
payment  in  international  transactions.  As  payment  is  made 
from  one  country  to  another,  say,  from  Buenos  Aires  to  New 
York,  the  Argentine  debtor  transfers  to  the  American  creditor 
title  to  a  portion  of  this  stock,  which  he  obtains  from  a  Buenos 
Aires  bank  in  exchange  for  local  gold,  and  the  American  creditor 
turns  it  over  to  a  New  York  bank  in  exchange  for  New  York 
gold. 

While  sterling  is  thus  the  paramount  exchange  in  most  mar- 
kets of  the  world,  nevertheless  payments  between  the  more 
important  countries  are  to  no  small  extent  effected  by  the  de- 
livery of  gold,  as  it  were,  in  their  respective  financial  centers. 
Each  of  these  cities  deals  in  exchange  on  the  others.  Thus  in 
New  York,  exchange  is  traded  in  on  Paris,  Berlin,  Vienna,  Ant- 

l6o 


OTHER  FOREIGN  EXCHANGES  IN  NEW  YORK  l6l 

werp,  Milan,  and  other  important  cities,  while  dollar  exchange 
is  dealt  in  in  each  of  these  centers  on  New  York. 

Apart  from  minor  variations,  due  to  differences  in  the  prac- 
tices of  dealers,  or  in  the  laws  of  the  countries  on  which  the 
exchanges  are  drawn,  dealings  in  these  various  remittances  in 
New  York  are  conducted  in  the  same  manner  as  in  exchange  on 
London.  In  each  case,  transactions  are  made  in  cable  transfers, 
demand  and  long  exchange,  for  both  spot  and  future  delivery, 
and  the  rates  are  subject  to  the  identical  laws  governing  the 
movements  of  the  sterling  quotation.  The  tendency  toward  the 
various  parity  relationships  is  far  less  pronounced  in  these  minor 
exchanges,  however,  than  it  is  in  sterling,  as  these  exchanges 
are  considerably  less  active  than  the  British  exchange. 

Exchanges  Quoted  in  New  York. — As  was  stated  in  the  first 
chapter,  different  countries  have  adopted  different  units  for 
measuring  quantities  of  the  standard  metal.  In  the  few  in- 
stances where  the  same  unit  is  used  by  several  countries,  it  is 
sometimes  designated  by  different  names.  Nor  is  there  com- 
plete uniformity  in  the  manner  in  which  New  York  dealers 
quote  the  exchanges  on  these  countries.  In  the  majority  of 
cases  the  rates  are  expressed  by  the  first  system  of  quotation, 
being  given  in  the  number  of  cents  (New  York  gold)  that  is 
offered  in  exchange  for  the  foreign  units  (foreign  gold).  In  a 
few  cases  the  second  system  of  quotation  is  employed,  the  rates 
being  denoted  by  the  number  of  foreign  units  that  are  exchange- 
able for  one  dollar. 

Franc  Exchange. — Exchange  on  Paris,  or  ^' franc  exchange," 
as  it  is  called  from  the  name  of  the  French  monetary  unit,  holds 
second  place  to  sterling  in  respect  to  the  volume  of  business  done 
in  it.  It  is  one  of  the  remittances  to  which  the  second  method 
of  quotation  is  applied,  its  rate  being  expressed  in  so  many 
francs  to  the  dollar.    As  the  franc  consists  of  4.4803  grains  of  gold, 


l62  FOREIGN  EXCHANGE 

5.18 J  francs  are  approximately  equivalent  to  $1  (that  is,  ^-iS^  X 
4.4803  =  roughly  23.22),  and  is,  therefore,  the  par  of  exchange, 
since  a  rate  at  that  figure  signifies  that  23.22  grains  of  Paris 
funds  exchange  for  the  same  amount  of  New  York  funds.  If  5.20 
is  quoted,  the  rate  is  at  a  discount,  for  in  that  case  23.2975 
grains  of  Paris  funds  bring  only  23.22  grains  of  New  York  funds. 
On  the  other  hand,  if  the  quotation  is  5.17  francs,  it  is  at  a  pre- 
mium, since  only  23.1631  grains  of  Paris  funds  are  required  to 
obtain  23.22  grains  of  New  York  funds.  In  short,  Paris  exchange 
is  at  a  discount  when  the  figure  indicating  its  rate  is  above  5.i8|^ 
francs,  and  at  a  premium  when  the  figure  is  below  5.18^  francs. 
The  other  exchanges  in  New  York  whose  rates  are  expressed  in 
terms  of  their  respective  monetary  units  are  those  on  Italy, 
Switzerland,  and  Belgium,  all  of  which  countries  possess  the  same 
unit  as  France,  though  in  the  case  of  Italy  it  is  called  the  ''lira."^ 

Mark  Exchange. — Exchange  on  Berlin,  Hamburg,  and  other 
German  centers  is  usually  called  "mark  exchange,"  after  the 
name  of  the  German  monetary  unit.  Its  rate  is  quoted  at  so 
many  cents  per  i  mark,  or  according  to  the  first  method  of  quota- 
tion. As  the  German  unit  consists  of  5.5312  grains  of  gold,  it  is 
equivalent  to  23.82  cents  (5.5312  is  approximately  .2382  of  23.22). 
When  the  rate  is  quoted  at  23.82  cents,  it  is  obviously  at  par. 
As  the  quotation  is  expressed  in  American  gold,  it  is  at  a  premium 
when  it  rises  above  23.82  cents,  and  at  a  discount  when  it  falls 
below  this  figure. 

Canadian  Exchange. — Exchange  on  Canada  affords  an  exam- 
ple of  the  use  of  a  monetary  unit  common  to  both  countries.    The 


^  It  will  be  observed  that  since  each  of  these  exchanges  is  quoted  in  terms 
of  its  respective  monetary  unit,  that  is,  in  foreign  gold,  the  percentage  of  any 
ruling  premium  or  discount  is  arrived  at  by  dividing  the  prevailing  rate  (not 
par)  into  the  difference  between  that  rate  and  the  par  of  5.18^  francs  (see 
footnote,  page  19). 


OTHER  FOREIGN  EXCHANGES  IN  NEW  YORK 


163 


exchanges  are  transacted  principally  with  Montreal,  and  it  is 
customary  to  quote  the  rate  by  expressing  the  percentage  of  the 
existing  premium  or  discount.  Thus  a  rate  of  yS%  premium 
signifies  that  $1,000  (or  23,220  grains  of  Montreal  gold)  com- 
mands looy^g  %  of  that  amount  of  New  York  gold.  Practically  all 
the  other  exchanges  traded  in  New  York  are  quoted  at  so  many 
cents  to  the  foreign  unit,  after  the  manner  of  mark  exchange. 

Countries  Dealt  with  by  New  York. — Following  is  a  list  of 
the  monetary  units  of  the  principal  countries  on  which  exchange 
is  dealt  in  at  New  York,  together  with  the  amount  of  fine  gold 
contained  in  each  and  their  respective  pars  of  exchange,  which 
are  expressed  in  the  American  unit  in  the  case  of  those  exchanges 
which  are  in  practice  quoted  in  terms  of  New  York  gold,  and  in 
the  foreign  units  where  the  exchanges  are  in  practice  quoted  in 
terms  of  foreign  gold: 


Name  of 
Unit 

Pure  Gold 

Par  of  Exchange 

Par  of  Ex- 

Country 

Content  in 

in  the  Ameri- 

change in  the 

Grains 

can  Unit 

Foreign  Unit 

Great  Britain 

Pound  Sterling 

1 13.001 

^4-8665 

France 

Franc 

4.4803 

5.'i8i 

Switzerland 

Franc 

4.4803 

5.i8i 

Belgium 

Franc 

4.4803 

.... 

5.18I 

Italy 

Lira 

4.4803 

.... 

5.18I 

Spain 

Peseta 

4.4803 

19.295  cents 

Greece 

Drachma 

4.4803 

19295      ' 

.... 

Germany 

Mark 

5.5312 

23.82 

.... 

Holland 

Guilder 

9-33 

40.195      ' 

.... 

Denmark 

Kroner 

6.2226 

26.8 

Norway 

Kroner 

6.2226 

26.8 

Sweden 

Kroner 

6.2226 

26.8 

.... 

Russia 

Rouble 

11.9465 

51.46 

.... 

Austria 

Krone 

4.7049 

20.26       ' 

.... 

Japan 

Yen 

11.5742 

49.84 

Triangular  Parity  when  Rates  Are  Quoted  as  Usual.— A 
word  of  explanation  is  first  necessary  before  examining  the  tri- 


l64  FOREIGN  EXCHANGE 

angular  parity  relation  of  the  rates  for  the  exchanges  between 
three  centers,  as  illustrated  in  the  case  of  New  York,  London, 
and  Paris,  when  quoted  in  the  regular  way.  The  price  for 
sterling  exchange  in  Paris  is  regularly  expressed  in  terms  of  so 
many  francs  to  the  pound  sterling,  or  according  to  the  first  system 
of  quotation.  As  the  franc  contains  4.4803  grains  of  gold  and 
the  pound  sterHng  1 13.001  grains,  25.22!^  francs  are  approxi- 
mately equivalent  to  £1  sterling,  and  represent,  accordingly,  the 
par  for  sterling  exchange  in  Paris. 

To  take  an  example  of  triangular  parity,  suppose  sterling 
cables  are  $4.86  in  New  York  and  25.22  francs  in  Paris.  If  at 
the  same  time  the  rate  for  franc  cables  in  New  York  is  5.1890 
francs  to  the  dollar,  so  that  25.22  francs  of  Paris  cables  can  be 
purchased  for  $4.86,  it  will  cost  equally  as  much  to  remit  to 
London,  whether  it  is  done  by  the  purchase  of  sterling  cables  in 
New  York,  or  by  the  purchase  in  turn  of  franc  cables  in  New 
York  and  sterling  cables  in  Paris.  When  the  three  quotations 
are  in  this  relative  position,  they  are  manifestly  in  triangular 
parity,  and  5.1890  francs  for  Paris  cables  in  New  York  is  the 
parity  of  the  sterHng  cable  rates  in  New  York  and  Paris. 

The  Narrow  Market  and  Readjustment. — When  the  three 
rates  are  thrown  out  of  this  parity  relationship,  a  process  of 
readjustment  in  the  demand  and  supply  of  each  of  the  three 
exchanges  immediately  sets  in,  which  tends  to  restore  the  equi- 
librium. In  the  course  of  this  readjustment  all  three  quotations 
y  imdergo  modification.  But  the  greatest  alteration  occurs  in 
the  exchange  possessing  the  narrowest  market.  As  the  sterling 
markets  in  New  York  and  Paris  are  considerably  more  active 
than  the  franc  market  in  New  York,  and,  therefore,  less  respon- 
sive to  the  same  volume  of  buying  and  selling,  triangular  parity 
between  their  rates  is  established  to  a  far  greater  extent  through 
a  movement  in  the  franc  quotation  in  New  York  than  by  any 
shifts  in  the  sterHng  rates  in  New  York  and  Paris,  which  are 


OTHER  FOREIGN  EXCHANGES  IN  NEW  YORK  165 

controlled  by  the  condition  of  the  ordinary  demand  and  supply 
rather  than  by  that  resulting  from  any  existing  disparity. 

Indeed,  to  such  degree  is  the  franc  rate  dependent  ordinarily 
on  the  relative  positions  assumed  by  the  sterUng  quotations  in  / 
New  York  and  Paris,  that  New  York  bankers  hesitate  to  do 
business  in  Paris  exchange  until  they  have  been  advised  by  cable 
of  the  rate  for  sterling  cables  in  Paris.  Having  obtained  that 
quotation,  they  proceed  to  calculate  the  parity  rate  for  Paris 
cables  in  New  York,  to  which  they  adjust  their  market  price,  as 
well  as  the  prices  for  the  other  forms  of  franc  exchange.  If,  for 
example,  a  rate  of  25.23  francs  is  cabled  for  sterHng  cables  in  Paris, 
and  the  sterling  rate  in  New  York  is  $4.86,  they  immediately  make 
their  quotations  for  franc  cables  conform  to  the  parity  rate  of 
5.1913  francs,  which  they  arrive  at  by  dividing  4.86  into  25.23. 

Given  a  stationary  rate  for  sterhng  cables  in  New  York,  the 
franc  cable  rate  in  New  York  declines  (the  figure  indicating  it 
rises)  as  the  sterling  rate  in  Paris  advances;  and  vice  versa,  the 
franc  cable  rate  advances  (the  figure  declines)  as  the  sterling 
rate  in  Paris  declines.  On  the  other  hand,  if  the  sterling  rate  in 
Paris  remains  unchanged,  the  franc  cable  rate  in  New  York  rises 
and  falls  with  the  sterling  rate  in  New  York.  A  similar  tendency 
to  subordination  to  sterling  is  shown  by  the  rates  for  exchanges 
on  the  other  centers.  Thus,  sterling,  by  reason  of  its  preponder- 
ant activity  in  most  of  the  markets  of  the  world,  is  the  pivotal 
exchange,  on  which  the  other  exchanges  more  or  less  hinge. 

Bankers  the  world  over  are  constantly  cabling  each  other  the 
rates  obtaining  in  their  respective  markets,  and  very  often  the 
prices  at  which  they  stand  ready  to  buy  or  sell  cable  exchange 
on  other  centers.  With  these  rates  before  them  they  compute 
the  various  triangular  parities  and  determine  the  cheapest  way 
of  remitting  to  or  from  a  particular  center,  whether  direct  or  by 
way  of  one  or  two  intermediate  points,  and  also  the  comparative 
profitableness  of  effecting  three-cornered  arbitrages,  as  explained 
in  Chapter  VII. 


I66  FOREIGN  EXCHANGE 

Swapping  Foreign  Currencies  in  New  York. — Occasionally 
it  happens  that  a  bank  desires  to  dispose  of  franc  cables  and  to 
acquire  sterling  cables  at  one  and  the  same  time.  Its  obvious 
course  in  that  case  is  either  to  make  two  exchanges  in  New  York 
by  selling  francs  and  buying  sterling,  or  to  make  one  exchange 
in  Paris  by  purchasing  sterling  cables  there.  It  also  has  the 
third  alternative  of  making  a  single  direct  exchange  of  the  francs 
\  for  sterling  in  New  York.  Such  an  exchange  of  Paris  gold  for 
London  gold  contracted  in  New  York  is  known  as  "swapping,'' 
and  is  executed  on  the  basis  of  the  prevailing  rates  for  sterHng 
and  franc  cables  in  New  York.  If  sterling  cables  are  quoted 
$4.86  and  franc  cables  5.18  francs,  the  swap  is  negotiated  in  the 
neighborhood  of  25. 17  J  francs  (4.86  X  5.18)  to  the  pound  sterling, 
which,  it  will  be  noticed,  is  the  triangular  parity  rate  for  sterling 
cables  in  Paris. 


APPENDIX  A 

PRACTICAL  PROBLEMS  IN  FOREIGN 
EXCHANGE 

1.  A  New  York  banker  desires  to  remit  at  once  to  London  to  meet 
some  long  bills  maturing  1 2  days  hence,  when  the  next  New  York  mail 
is  due  in  London.  He  can  lend  in  New  York  at  5%  and  borrow  in  Lon- 
don at  4%.  If  the  rate  for  sterling  spot  cables  is  $4.8625,  the  demand 
rate  $4.8570,  and  the  rate  for  12-day  future  cables  $4.8620,  which  of  the 
three  forms  of  remittance  will  cost  him  least? 

2.  Assume  the  conditions  of  Problem  i. 

(a)  Which  two  classes  of  exchange  would  a  banker  select  for  the  most 
profitable  arbitrage? 

(b)  What  would  his  profit  be  on  £100,000  of  whatever  form  of  ex- 
change he  sold  on  the  operation? 

3.  A  New  York  banker  wishes  to  avail  himself  of  prevailing  exchange 
rates  to  transfer  certain  funds  to  New  York.  He  will  come  into  posses- 
sion of  these  funds  in  London  10  days  hence,  which  time  marks  the  end 
of  the  current  mailing  period  from  London  to  New  York.  The  sterling 
spot  cable  rate  in  New  York  is  $4.8625  and  the  demand  rate  $4.8575, 
while  the  dollar  spot  cable  rate  in  London  is  $4.8630. 

(a)  If  the  London  interest  rate  is  3%,  which  of  the  three  methods  of 
transfer  is  the  most  advantageous? 

(b)  Which  is  the  most  profitable  arbitrage  between  the  three  ex- 
changes? 

(c)  What  is  the  arbitrageur's  profit  on  every  £100,000  of  exchange 
he  either  sells  or  purchases? 

4.  Suppose  interest  is  at  the  rate  of  6%  in  New  York  and  5%  in 
London,  and  that  10  days  are  required  for  a  draft  to  go  by  mail  in  either 
direction  between  the  two  cities. 

(a)  If  the  sterling  spot  cable  rate  in  New  York  is  $4.8605  and  the 
demand  rate  $4.8550,  while  the  dollar  spot  cable  rate  in  London  is  $4.86 
and  the  demand  rate  $4.8670,  by  which  of  the  four  methods  will  a  New 
York  banker  who  has  a  debt  maturing  in  London  10  days  hence  remit 
most  cheaply? 

(b)  Between  which  two  is  an  arbitrage  most  profitable? 

167 


I68  APPENDIX 

(c)  What  amount  of  profit  does  the  arbitrageur  reaHze  on  £100,000 
of  sterHng  exchange  he  either  sells  or  purchases? 

5.  A  New  York  merchant  has  purchased  a  quantity  of  wool  in  Argen- 
tina, for  which  he  remits  to  Buenos  Aires  a  demand  draft  on  London  for 
£25,000.  The  price  of  sterling  spot  cables  in  New  York  is  $4.87  and 
the  London  interest  rate  is  5%.  What  has  the  draft  cost  him  approxi- 
mately, assuming  that  mail  is  30  days  in  transit  from  New  York  to  Buenos 
Aires,  and  the  same  length  of  time  from  Buenos  Aires  to  London? 

6.  In  October,  1919,  spot  cables  on  Paris  were  quoted  at  the  ab- 
normally low  rate  of  8.65  francs. 

(a)  What  percentage  of  discount  did  this  rate  represent? 

(b)  If  dollar  spot  cables  in  Paris  were  at  parity  with  the  franc  quota- 
tion in  New  York,  what  was  the  percentage  of  their  premium? 

7.  Banker  Smith  swaps  with  banker  Brown  £75,000  of  demand  ex- 
change for  the  same  amount  of  cable  transfers  on  the  basis  of  $4.8545 
for  demand  and  $4.8595  for  cables.     What  settlement  is  made? 

8.  Banker  Doe  swaps  with  banker  Roe  £60,000  of  60-day  sight  bills 
for  an  equal  amount  of  90-day  sight  bills  on  the  basis  of  $4.82!  for  the 
former  and  $4.81  for  the  latter.     How  is  the  transaction  settled? 

9.  The  price  of  demand  sterling  exchange  in  New  York  is  $4.8635 
and  the  London  discount  rate  ''to  arrive"  for  60-day  sight  bills  is  3%. 
A  banker  purchases  £50,000  of  60-day  sight  cotton  bills  at  the  rate  of 
$4.8335,  which  he  intends  to  discount  immediately  upon  arrival  in  Lon- 
don, and  at  the  same  time  he  sells  demand  exchange  for  the  amount  of 
the  prospective  proceeds.     What  is  the  amount  of  his  profit? 

10.  Money  is  lending  in  New  York  at  4%,  the  London  discount 
rate  "to  arrive"  is  3 J%,  and  bankers'  90-day  sight  bills  on  London  are 
selling  in  New  York  at  $4.82!.  If  the  price  of  demand  sterling  for  de- 
livery in  93  days  is  $4.8725,  and  the  commission  charge  of  the  London 
accepting  bank  is  -5%,  will  it  advantage  a  New  York  banker  to  sell  his 
90-day  sight  bills  and  purchase  future  demand  at  the  aforementioned  rate? 

11.  A  New  York  banker  purchases  £100,000  worth  of  60-day  sight 
bills  at  $4.8i-g-  for  investment  to  maturity,  and  sells  against  them  demand 
exchange  for  delivery  in  63  days  at  the  rate  of  $4.8560.  Assuming  that 
the  demand  draft  will  be  cashed  on  the  day  the  long  bills  are  paid,  what 
interest  rate  will  the  investment  net  the  banker? 

12.  A  London  banker  advances  $100,000  in  New  York  for  3  months 
at  5%,  buying  dollar  spot  cables  at  the  rate  of  $4.8650.  Upon  the  ma- 
turity of  the  loan,  he  recalls  his  funds  to  London  by  selling  dollar  cables 
at  the  rate  of  $4.86.    What  has  been  the  rate  of  his  interest  return? 


PRACTICAL  PROBLEMS  1 69 

13.  A  British  corporation  floats  a  dollar  bond  issue  in  this  country, 
the  interest  and  principal  of  which  are  payable  at  the  option  of  the  holders 
either  in  New  York  at  the  face  amount,  or  in  London  at  the  rate  of  £1 
per  $4.8665  of  the  face  amount.  Just  prior  to  the  departure  of  the  last 
New  York  mail  to  reach  London  in  time  for  the  maturity  of  the  bonds, 
sterling  cables  for  delivery  on  the  due  date  of  the  bonds  are  quoted  $4.87. 
Where  will  it  pay  bankers  of  both  cities  to  present  their  holdings  of  the 
securities  for  payment,  assuming  that  the  cost  of  insuring  bonds  forwarded 
from  one  center  to  the  other  is  tV%j  of  their  face  amoimt? 

14.  Sterling  exchange  in  Amsterdam,  Holland,  is  quoted  at  so  many 
guilders  per  £1,  which  is  equivalent  to  12.107  guilders. 

(a)  If  the  market  rate  for  sterling  cables  is  12.10  guilders  in  Amster- 
dam and  $4.8605  in  New  York,  what  is  the  rate  for  guilder  cables  in  New 
York  in  triangular  parity  with  the  two  sterling  rates? 

(b)  If  the  guilder  cable  rate  is  actually  quoted  $.401,  what  profit  will 
a  New  York  banker  realize  per  £1  on  an  arbitrage  operation  between 
the  three  centers? 

15.  In  Italian  centers,  sterling  rates  are  expressed  in  so  many  lire  to 
£1  (£1  =  25.22J  lire). 

(a)  If  sterling  cables  are  quoted  25.205-  lire  in  Milan  and  $4.8575  in 
New  York,  what  is  the  triangular  parity  rate  of  lire  cables  in  New  York? 

(b)  Assuming  that  the  market  rate  for  Milan  cables  in  New  York  is 
5.18  lire,  what  profit  per  £1  will  a  New  York  banker  realize  on  a  triangular 
arbitrage  operation  between  the  three  cities? 


APPENDIX  B 

GLOSSARY  OF  FOREIGN  EXCHANGE  TERMS 

Acceptance.    A  draft  which  the  drawee  has  bound  himself  to  pay  at 

maturity  by  writing  across  its  face  the  word  "Accepted"  and  his 

signature.     (See  also  " Bank  Acceptance "  and  "Trade  Acceptance.") 
Acceptance  Credit.    Engagement  on  the  part  of  a  bank  to  accept 

under  certain  stipulated  conditions  a  specified  amount  of  bills  in 

behalf  of  a  borrower  or  buyer  of  goods. 
Acceptor.    One  who,  as  drawee,  accepts  a  bill  of  exchange  or  draft. 
Accommodation  Paper.    A  bill,  draft,  or  promissory  note  which  is 

accepted  or  indorsed  by  one  person  for  another  without  consideration 

to  enable  the  latter  to  raise  money  on  it. 
American  Exchange.    (See  "Dollar  Exchange.") 
Arbitrage.    A  simultaneous  purchase  and  sale  performed  by  the  same 

operator  between  two  classes  of  exchange  in  the  one  market,  or 

between  the  same  or  different  classes  of  exchange  in  different  markets. 
Arbitrageur.    One  who  performs  an  arbitrage  transaction. 
Bank  Acceptance.    A  bill  of  exchange  which  is  drawn  on  and  accepted 

by  a  bank. 
Bankers'  Bills.      Those   drawn  by   banks   and  bankers  on  foreign 

correspondents. 
Bill  Broker.    London  dealer  in  bills  of  exchange. 
Bill  of  Exchange.    An  order  drawn  by  one  party  on  another  to  pay 

a  designated  sum  of  money  to  a  third  party. 
Bill  of  Lading.    Document  the  shipper  of  goods  receives  from  the 

transportation  company,  evidencing  his  title  to  the  goods. 
Cable  Transfer.    Remittance  by  cablegram. 
Cambist.    Same  as  foreign  exchange  dealer. 
Check.    Formal  written  order  which  a  depositor  draws  on  his  bank 

to  pay  an  indicated  sum  of  money  to  a  designated  party. 
Clean  Bill.  One  unaccompanied  by  shipping  documents. 
Commercial  Bills.    Those  drawn  by  exporters  of  merchandise,  either 

on  the  foreign  buyers  or  their  banks. 
Confirmed  Acceptance  Credit.    One  which  the  issuing  bank  may  not 

cancel. 

170 


GLOSSARY  OF  FOREIGN  EXCHANGE  TERMS  171 

Consignee.    One  to  whom  goods  are  shipped. 

Date  Bills.  Drafts  payable  a  certain  period  after  the  day  of  their  issue. 

Demand  Exchange.    Draft  payable  upon  presentation. 

Discount  House.    Incorporated  company  dealing  in  bills  of  exchange. 

Discount  Rate  *'to  Arrive."    Rate  at  which  London  bill  brokers 

and  discount  houses  agree  in  advance  to  discount  bills  for  foreign 

banks  upon  arrival  in  London. 
Disparity.    Opposite  of  parity.     (See  "Parity.") 
Documentary    Acceptance    Bill.    One    accompanied    by    shipping 

documents,  including  bill  of  lading,  which  is  surrendered  to  drawee 

upon  his  accepting  the  draft. 
Documentary  Payment  Bill.    One  accompanied  by  shipping  docu- 
ments, including  bill  of  lading,  which  is  surrendered  to  the  drawee 

only  upon  his  paying  the  draft. 
Dollar  Exchange.     Exchange   on   an   American   center,   particularly 

New  York. 
Dollar  Export  Credit.     One  issued  by  an  American  bank  to  finance 

merchandise  exports. 
Dollar  Import  Credit.     One  issued  by  an  American  bank  to  finance 

merchandise  imports. 
Domiciled  Bills.     Draft  drawn  upon  one  country  but  made  payable 

in  another. 
Drawee.    The  party  on  whom  a  bill  of  exchange  or  draft  is  drawn. 
Drawer.     One  who  draws  a  bill  of  exchange  or  draft. 
Exchange  Discount.    The  amount  by  which  the  prevailing  rate  of 

exchange  is  below  par:  also  the  amount  by  which  the  price  of  one 

type  of  exchange  is  below  its  parity  rate  as  regards  the  price  of 

another  type. 
Exchange  Premium.    Theamountby  which  the  current  rate  of  exchange 

exceeds  par;  also  the  amount  by  which  the  price  of  a  particular  type 

of  exchange  exceeds  its  parity  rate  as  regards  the  price  of  another 

type. 
Finance  Bills.    Long  bankers'  bills  secured  by  stock  and  bond  collateral. 
First  of  Exchange.    Original  copy  of  bill  of  exchange  remitted  by  the 

first  departing  steamer. 
Foreign  Exchange  Banker.    A  banker  who  deals  in  foreign  exchange 

and  carries  balances  abroad  for  the  purpose. 
Franc  Exchange.    Exchange  on  a  French  center,  particularly  Paris. 
Future  Exchange.     Contract  for  an  exchange  of  funds  between  two 

countries  at  a  fixed  rate  at  a  specified  future  time. 


172  APPENDIX 

Gold  Export  Poestt.     Rate  at  which  the  purchase  of  a  particular  class 

of  exchange  is  equivalent  to  exporting  gold. 
Gold  Import  Point.     Rate  at  which  the  sale  of  a  particular  class  of 

exchange  is  equivalent  to  importing  gold. 
Indorsement.    Writing  on  back  of  bill  of  exchange,  draft,  or  promissory- 
note,  whereby  the  instrument  is  assigned  and  transferred  to  another 

party,  with  or  without  guarantee  of  its  payment. 
Irrevocable  Credit.     (See  "Confirmed  Acceptance  Credit.") 
Legal  Tender.    Form  of  money  which  a  creditor  is  legally  bound  to 

accept  in  full  satisfaction  of  his  claim.     In  United  States,  gold  coin, 

silver  dollars,  and  United  States  notes  are  by  statute  declared  to 

be  good  and  sufficient  payment  of  debts. 
Letter  of  Credit.    Document  issued  by  bank  in  connection  with  an 

acceptance  credit  it  has  granted,  authorizing  its  recipient  to  draw 

bills  upon  the  bank  against  merchandise  shipments  for  the  amount 

and  in  accordance  with  the  conditions  specified. 
Long  Exchange.    Draft  running  for  a  stated  period  from  the  day  it  is 

accepted  or  drawn. 
Long  Sight  Bills.    Those   running   a   designated   period   after   their 

acceptance. 
Mark  Exchange.    Exchange  on  a  German  center. 
One-Name  Bill.     A  draft,  the  drawer  and  drawee  of  which  are  affiliated 

concerns  and,  therefore,  represent  but  a  single  financial  responsibility. 
Parity.    Equivalence  of  two  different  classes  of  exchange. 
Parity  Spread.    Difference  between  the  quotations  for  two  forms  of 

exchange  when  at  parity  with  each  other. 
Par  of  Exchange.    Rate  at  which  foreign  and  domestic  funds  exchange 

for  each  other  on  equal  terms,  and  which  is  usually  denoted  by  the 

number  of  domestic  monetary  units,  or  the  fraction  of  the  domestic 

unit  that  is  equivalent  to  the  foreign  unit,  or  vice  versa. 
Payee.     One  who  is  paid  or  is  to  be  paid  a  certain  sum  of  money. 
*'PiG  ON  Pork."    One-name  bill. 
Price  of  Exchange.    Same  as  rate  of  exchange. 
Prime  Biil.    One  selling  at  the  highest  prevailing  price  by  reason  of 

the  high  credit  standing  of  both  drawer  and  drawee. 
Prompt  Exchange.      Same  as  spot  exchange.     (See  "Spot  Exchange.") 
Rate  of  Exchange.    The  ratio  in  which  domestic  funds  exchange  for 

foreign  funds. 
Rate  to  Arrive.     (See  "Discount  Rate  *to  Arrive.'  ") 
Ready  Exchange.       Same  as  spot  exchange.     (See  "Spot  Exchange.") 


GLOSSARY  OF  FOREIGN  EXCHANGE  TERMS  1 73 

"Retirement  Rate"  of  Discount.  Rate  at  which  non-discountable 
sterHng  bills  may  be  retired  in  London  before  maturity. 

Revocable  Acceptance  Credit.  One  in  which  the  issuing  bank 
reserves  the  right  to  cancel  at  any  time  any  unused  portion. 

Second  of  Exchange.  Duplicate  copy  of  bill  of  exchange  remitted  by 
second  steamer. 

Shipping  Documents.  Papers  attached  to  commercial  bills  of  exchange, 
including  bill  of  lading,  insurance  certificate,  invoice,  and  other 
papers. 

Sight  Exchange.  Same  as  demand  exchange.  (See  "Demand  Ex- 
change.") 

Specie  Points.     Gold  export  and  import  points. 

Spot  Exchange.     Immediate  remittance. 

Spot  Gold.    Gold  available  for  immediate  delivery. 

Sterling  Exchange.    Exchange  on  British  centers,  particularly  London. 

Sterling  Export  Credit.  Credit  issued  by  London  banks  to  finance 
merchandise  exports  from  this  country. 

Sterling  Import  Credit.  Credit  issued  by  London  banks  to  finance 
imports  into  this  country. 

''Swapping."  Exchanging  one  form  of  remittance  for  another  on  the 
same  city,  as  sterling  cable  transfers  for  sterling  demand;  or  ex- 
changing funds  between  two  foreign  cities,  as  sterling  for  franc 
exchange. 

Tenor  of  Bill.     Period  the  bill  runs. 

Three-Cornered  Exchange.  Same  as  triangular  exchange.  (See 
"Triangular  Exchange.") 

"To  Arrive."      (See  "Discount  Rate  '  to  Arrive.'  ") 

Trade  Acceptance.  A  bill  of  exchange  or  draft  drawn  by  the  seller 
of  goods  upon  the  buyer  and  accepted  by  the  latter. 

Triangular  Arbitrage.    Arbitraging  between  three  centers. 

Triangular  Exchange.  Remittance  from  one  center  to  another  by 
way  of  a  third. 

Triangular  Parity.  State  of  equilibrium  in  the  rates  of  exchange 
between  three  cities,  so  that  remittance  from  one  center  to  an- 
other, by  way  of  the  third,  costs  precisely  as  much  as  when  made 
directly. 

Trust  Receipt.  Legal  instrument  by  which  a  bank  which  has  accepted 
bills  to  finance  imports,  exercises  full  control  over  the  goods  upon 
their  arrival  in  this  country,  or  the  money  proceeds  in  case  of  their 
sale,  until  it  is  reimbursed  for  the  amount  of  the  bills. 


174  APPENDIX 

Two-Name  Bill.  Draft,  the  drawer  and  drawee  of  which  are  mutually 
independent  parties  and,  therefore,  represent  separate  financial 
entities. 

Unconfirmed  Credit.  Same  as  revocable  credit.  (See  ''Revocable 
Acceptance  Credit.") 

Usance  of  Bill.    Period  the  bill  runs.     (See  ''Tenor  of  Bill.") 


INDEX 


Acceptance,  commission  for,  95 
Acceptance  credit,  extended  against 

exports,  135 
Alloy,  in  gold  coins,  4 
American  dollar,  defined,  119 
American    exchange     (See    "Dollar 

exchange") 
American  monetary  system,  119-121 

legal  tender  money,  120 
Arbitrage, 
demand  and  long  exchange, 
long  rate  at  discount,  92 
long  rate  at  premium,  93 
purchase  of, 

demand  exchange  against  gold 

imports,  80 
spot  cable  exchange  against  gold 
importation,  30 
sale  of, 

demand    exchange    against    ex- 
port of  gold,  77 
spot  cable  exchange  against  ship- 
ment of  gold,  27 
various      forms      of      exchange 
against  gold  exports,  78 
spot  cable  and  demand  exchange, 

74.  75 

spot  cable  and  future   cable   ex- 
change, 61,  62 

spot  cable  rate  in  one  center, 
above  parity  rate  in  other,  44 
below  parity  rate  in  other,  47 

triangular  exchange, 
and  gold  shipments.  108 
in  different  methods,  109 
rate  above  parity,  106 
rate  below  parity,  105 
Austrian  exchange,  par  of  exchange, 

163 

Austrian  krone,  gold  content,  163 

B 

Bank  deposits, 

differentiated  from  cash,  6 
equivalent  to  gold,  i 
form     of     money     generally     ex- 
changed, I 


Bankers'  cables, 

no  distinction  made  with  commer- 
cial cables,  126 
Bank  money, 

engraved  notes  and  checking  de- 
posits, 5 
Bank  of  England  notes, 

equivalent  to  gold,  122 

full  legal  tender,  121 
Bank's  demand  obligations, 

issuance  and  retirement  of,  7 

redemption  of,  7 
Belgian  exchange, 

par  of  exchange,  163 

quoted  in  Belgian  gold,  162 
Belgian  franc,  gold  content,  163 
British  currency  notes, 

equivalent  to  gold,  122 

full  legal  tender,  122 
British  monetary  system,  explained, 
121 


Cable    exchange    (See    "Spot    cable 
exchange"   and    "Future   cable 
exchange") 
Canadian  exchange,  manner  of  quot- 
ing, 162 
Cash,  defined,  6 
*  Cash"  transactions, 
in  sterling  cables,  126 
in  sterling  demand  exchange,  128 
Checking  deposits,  defined,  5 
Clean  bill, 

not  accompanied  by  shipping  docu- 
ments, 144 
Coinage  of  gold, 

free  and  unlimited,  4 
gratuitous,  4 
Commercial    bills,    sterling    demand 

exchange,  128 
Commercial  business,  of  foreign  ex- 
change banker,  115 
Commercial  cables, 
no  distinction  made  with  bankers* 
cables,  126 
Cotton  exports,  terms  of  sale,  137 


175 


176 


INDEX 


Danish  exchange,  par  of    exchange, 

163 
Danish  krone,  gold  content,  163 
Date  bills,  long  sterling  bills,  153 
Demand  exchange, 
arbitraging  against  gold  exports,  77 
arbitraging  against  gold  imports,  80 
arbitraging    with    long    exchange, 

long  rate  at  discount,  92 

long  rate  at  premium,  93 
arbitraging    with    spot    cable    ex- 
change, 

demand  price  above  parity,  75 

demand  price  below  parity,  74 
dealt  m  m  foreign  center, 

gold  export  point,  81 

gold  import  point,  82 
defined,  71 

fundamental  characteristic  of,  70 
future  delivery,  85 
gold  export  point,  76 
gold     export     rate     expressed     in 

foreign  gold,  83 
gold  import  point,  78 
gold    import    rate    expressed     in 

foreign  gold,  84 
illustrative  case,  70 
movement  in   rate  in  relation  to 

spot  cable  rate,  76 
parity  with  long  exchange,  99 
parity  with  spot  cables  realized  to 

greatest  extent.  75 
plural  quotation,  76 
prime  bills,  76 
rate, 

explained,  71 

expressed  in  foreign  gold,  82 
relation  of  parity  rate  to, 

future  cable  rate,  77 

spot  cable  rate,  72 
relation  of  rate  to  long  exchange 

rate,  90 
tendency     to     parity     with     long 

exchange,  91-93 

long  rate  at  discount,  91 

long  rate  at  premium,  93 
tendency  to  parity  with  spot  cable 

exchange, 

rate  quoted  above  parity,  74 

rate  quoted  below  parity,  73 
traded  in  in  foreign  center, 

relation   of   rate  to   spot   cable 
rate.  81 


Demand  for  exchange  (See  "Foreign 

exchange") 
Direct  exchanges, 

New  York  and  centers  other  than 
London,  160 
Discount, 
on  dollar  exchange  in  London,  124 
on  foreign  exchange  (See  'Foreign 

exchange  *') 
on  sterling  exchange,  123 
Documentary  acceptance  bill, 
accompanied    by    shipping    docu 
ments  which  are  released  after 
acceptance,  14.1 
Documentary  payment  bill, 
accompanied    by    shipping    docu- 
ments which  are  released  alter 
payment,  143 
Dollar, 
defined. 3 
gross  weight  of.  4 
Dollar  cables  in  London, 

parity    with    dollar    demand    ex- 
change, I2S 
rate  tends  to  equality  with  sterling 
cables,  124 
Dollar  demand  exchange  in  London, 

parity  with  dollar  cables,  125 
Dollar  exchange, 
in  London. 

discount  on,  124 
manner  of  expressing  rates,  124 
par  of  exchange,  124 
premium  on,  124 
term  defined,  123 
Dollar   export   credit,    financing    ex- 
ports, 147 
Dollar  import  credit,  147 
Dollar  loan,  payable  m  America,  157 
"Domiciled"  bill, 

drawn  on  non-British  center   but 
payable  in  sterling,  141 
Dual  system  of  exchange,  39-41 
Dutch   exchange,  par   of    exchange, 

163 
Dutch  guilder,  gold  content,  163 


Federal  reserve  banks,  chief  owners 

of  gold  in  country,  121 
Finance  bill,  long  banker's  bill,  149 
Financing  cotton  shipment,  135-140 
"First  of  exchange,"  original  draft, 

127 


INDEX 


177 


Foreign  exchange, 

analysis  of  transaction  in,  8 

balancing  demand  against  increas- 
ing supply,  23 

balancing  supply  against  increasing 
demand,  22 

contracted  between  people  of  differ- 
ent countries,  37 

discount  on,  17 
causes  of,  23 
rate  favorable,  23 

dual  system,  34,  39-41 

foreign  gold  given  in  exchange,  16 

general  definition  of,  i 

method  of  calculating  percentage 
of  premium  and  discount,  19 

par  of,  17 

premium  on,  17 
causes  of,  21 
rate  adverse,  22 

quoting  rate  in, 
domestic  gold,  17 
foreign  gold,  18 

transaction  in,  illustrated.  10 

transactions  viewed  as  purchases 
and  sales,  16 

various  forms  of  (See  "Spot  cable 
exchange,"  "Future  cable  ex- 
change," "Demand  exchange," 
and  "Long  exchange") 

various  sources, 
of  demand,  20 
of  supply,  21 

viewed  from  opposite  standpoints, 

35 
Foreign  exchange  banker, 

bank  balances  carried  by,  114 

capital  employed  by,  114 

commercial  dealings,  115 

converts  one  type  of  exchange  into 
another,  113 

distributing  agent,  112 

financial  operations,  117 

foreign  correspondents,  114,  118 

function  of,  1 1 1 

lends  credit,  113 

to  sellers  and  buyers  of  future 

exchange,  113 
to  sellers  of  spot  exchange,  113 

miscellaneous  activities,  118 

open-market  trading,  116 

profits  of,  112 

quotes  double  price,  112 
Foreign  exchange  department,  mana- 
ger of,  114 


Foreign  exchange  manager,  interest 

charged  him  on  capital,  115 
Foreign  exchange  market, 
centering  in  New  York,  112 
minor  centers,  112 
quotations  in,  112 
unity  of  markets  in  two  cities,  34 
Franc,  gold  content,  161,  163 
Franc  exchange, 

par  of  exchange,  162,  163 
quoted  in  French  gold,  161 
Funds, 

remitting  funds,  16 
withdrawing  funds,  16 
Future  cable  exchange, 
arbitraging    with    spot    cable    ex- 
change, 
future     parity     above     current 

future  rate,  61 
future     parity     below     current 
future  rate,  60 
dealt  in  in  foreign  center,  relation 

of  rate  to  spot  cable  rate,  67 
formula  of  parity  rate  to  spot  cable 

rate,  59 
gold  export  point,  63 

in  foreign  center,  68 
gold  import  point,  64 
in  foreign  center,  68 
rate,  54 

expressed  in  foreign  gold,  68 
relation  of  parity  rate, 
to  demand  rate,  ']^ 
to  spot  cable  rate,  59 
specie  points, 

relation  of  to  gold 
shipments,  66 

when    maturity    varies    from 
shipping  period,  66 _ 
tendency  of   rate   to   parity  with 

spot  cable  rate,  60-62 
tendency  to  parity  with  spot  cable 
exchange, 
future  parity  rate  above  current 

future  late,  61 
future  parity  rate  below  current 
future  rate,  60 
Future    contracts,    same    as    future 

exchange,  53 
Future  exchange, 
defined,  53 
delivery  dates,  56 
purpose  of,  53-55 
sources  of, 
demand,  55 


178 


INDEX 


Future  exchange — Continued 

sources  of — Continued 
supply,  55 

speculation  in,  55 

typical  transaction,  53 
Future  sterling  exchange, 

banks  as  source  of  demand  and 
supply,  133 

conversion  into  spot  exchange,  133 

"swapping"  for  spot  exchange,  134 
Futures,  same  as  future  exchange,  53 


German  exchange,  par  of  exchange, 

162,  163 
German  mark,  gold  content,  162,  163 
Gold, 

borrowing  in  connection  with  ship- 
ment, 31 

coining  of,  3 

free  and  unlimited  coinage  of,  4 

loss  from  abraded  coins,  3 1 

sold  at  discount,  31 

sole  full  legal  tender,  5 

standard  of  values,  2 
Gold  bars, 

premium  charged  by   New  York 
Assay  Office,  132 
Gold  coins,  alloy  in,  4 
Gold  discount, 

maximum  amount  Bank  of  Eng- 
land may  charge,  132 
Gold  export  point, 

demand  exchange,  76 

expressed  in  foreign  gold,  83 
in  foreign  center,  8 1 

formula  of,  in  foreign  center,  51 

future  cable  exchange,  63 
in  foreign  center,  68 

spot  cable  exchange,  rate  expressed 
in  foreign  gold,  52 

spot  cables,  26 

triangular  exchange,  107 

varies  with  different  shippers,  27 
Gold  import  point, 

demand  exchange,  78 

expressed  in  foreign  gold,  84 
in  foreign  center,  82 

formula  of,  in  foreign  center,  50 

future  cable  exchange,  64 
in  foreign  center,  68 

spot  cable  exchange,  rate  expressed 
in  foreign  gold,  52 

spot  cables,  29 


triangular  exchange,  108 
varies  with  different  individuals,  30 
Gold  reserves, 

concentrated  in  government  treas- 
ury and  central  bank,  7 
held  by  banks  and  government,  7 
Gold  sales  in  London, 

Bank  of  England's  maximum  dis- 
count, 132 
Gold  shipment. 
New  York  to  London,  illustrated, 

130-33 
triangular      exchange,      arbitrage 
against,  108 
Gold  standard, 
explained,  2-8 
real  significance,  4 
Gold  Standard  Act  of  1900,  status  of 

silver  dollars,  120 
Gold  stocks  in  United  States, 

concentrated  in  government  Treas- 
ury and  federal  reserve  banks, 
121 
Government's    demand    obligations, 
issuance  and  retirement  of,  7 
redemption  of,  7 
Government  money,  subsidiary  coins 

and  engraved  notes,  5 
Greek  drachma,  gold  content,  163 
Greek    exchange,  par    of    exchange, 

163 
Greenbacks     (See    "United     States 
notes") 


Indirect  remittance, 

two  or  more  intermediate  points, 
109 
International  bond  issues, 

payable  in  either  country,  158 

sold  as  demand  exchange,  159 
International  loans, 

dollar  loan,  157 

sterling  loan,  155 
International  trade  settlements,  made 

through  London,  160 
Investment    demand,    long    sterling 

bills,  152 
Investment,  in  long  bills,  94 
Italian  exchange, 

par  of  exchange,  163 

quoted  in  Italian  gold,  162 
Italian  lira,  gold  content,  163 


INDEX 


179 


Japanese  exchange,  par  of  exchange, 

163 
Japanese  yen,  gold  content,  163 


Legal  tender  money,  American, 
silver  dollars,  120 

Treasury  notes  of  1890,  120 

United  States  notes,  120 
Legal  tender  money,  British, 

Bank  of  England  notes,  121 

currency  notes,  122 
Letter  of  credit, 

confirmed  or  irrevocable,  137 

evidencing  authority  to  draw  bills, 
136 

unconfirmed  or  revocable,  137 
London  bank  deposit, 

equivalent    to    gold'   delivered    in 
London,  122 
London  exchange, 

controls  rates  of  other  exchanges, 
no 

premier  exchange,  103 
London,  international  money  center, 

160 
Long  bankers'  bills, 

finance  bill,  149 

one-name  bill,  151 

parity  price  of,  148 

sale  against  purchase  of  commer- 
cial bills,  149 

two-name  bill,  151 
Long    bills     (See    also    "Long    ex- 
change") 

acceptance  of,  86,  87 

British  stamp  tax  on,  87 

collateral  security  behind,  98 

instruments  of  borrowing,  95 

investment  buying  of,  94 

issued  for  borrowing  purposes,  95- 

97      .  .        , 

to  anticipate  receipt  of  money,  96 

to  relend  proceeds,  96 
issued  in  London  on  New  York,  100 
methods  of  handling,  87-90 

discounted  in  London,  88 

discounted  in  New  York,  90 

held  to  maturity,  87 
prime  variety,  98 
rate  quoted  in  foreign  gold,  99 
rate  "to  arrive"  on,  88 


renewal  of,  97 
security  of,  98 
spot  rate  of  interest  on,  88 
Long  commercial  bills, 
clean  bill,  144 

computing  price  of,  138-139 
documentary  acceptance  class,  141 

"domiciled"  bill,  141 
documentary  payment  class,  143 
Long  exchange, 
arbitraging  with  demand  exchange, 

rate  at  discount,  92 

rate  at  premium,  93 
defined,  86 

parity  with  demand  exchange,  99 
relation  of  rate  to  demand  rate,  90 
tendency  to  parity  with  demand 
exchange,  91-93 

rate  at  discount,  91 

rate  at  premium,  93 
Long  sterling  bills, 
commercial,  135 
date  bills,  153 

investment  demand  for,  152 
renewal  of,  152 
"swapping,"  152 


M 


Mark  exchange,  quoted  in  American 

gold,  162 
Monetary  unit,  defined,  3 
Money, 

composed  of  two  elements,  6 
defined,  i 

in  United  States,  gold,  or  govern- 
ment's and  banks'  demand  ob- 
ligations, 120 
medium  of  exchange,  2 
standard  of  values,  2 


N 


New  York  bank  deposit, 
equivalent    to    gold    delivered    in 
New  York,  121 
Norwegian  exchange,  par  of  exchange, 

163 
Norwegian  krone,  gold  content,  163 


One-name  bill,  long  banker's  bill,  151 
Open-market    trading,    foreign    ex- 
change banker,  of,  1 16 


i8o 


INDEX 


Parity, 

demand    exchange    and    long    ex- 
change, 90 
dollar  cable  and  demand  exchange 

in  London,  125 
gold   export   rates   of   spot   cable, 
future    cable,   and    demand   ex- 
change, 77 
long  and  demand  exchange,  99 
process  of  adjustment  to,  49 
promptness  of  tendency  to,  47 
spot  cable  and  demand  exchange, 

73 
spot   cable   and   future   cable   ex- 
change, 57-60 
spot  cable  rates,  37 

different   systems    of    quotation 
used,  51 
sterling    cables    and    demand    ex- 
change, 124 
tendency  of  gold  import  rates  to, 

80 
tendency  to,  between  spot  cables  in 

two  markets,  41-47 
tendency  to  universal  equilibrium, 

no 
triangular  exchange,  103 
Parity  spread, 

spot  cable  and  demand  rates,  be- 
tween, 73 
Par  of  exchange  (See  also  "Foreign 
exchange") 
dollar  exchange,  of,  124 
sterling  exchange  of, 

expressed  in  dollars,  123 
expressed  in  sterling,  123 
"Pig    on    pork"     (See     "One-name 

bill") 
Pound  sterling,  defined,  3,  121 
Premium, 

charged  on  gold  bars  by  New  York 

Assay  Office,  132 
dollar   exchange    in    London,    on, 

124 
sterling  exchange,  on,  123 
Premium  on  exchange  (See  "  Foreign 

exchange") 
Price  of  exchange  (See  "Rate  of  ex- 
change") 
Prime    bills,    sterling    demand    ex- 
change, 128 
Prompt  cable  exchange  (See  "Spot 
cable  exchange") 


Rate  of  exchange   (See  also   "Spot 
cable  exchange,"  "Future  cable 
exchange,"  "Demand  exchange," 
and  "Long  exchange") 
not  a  fixed  proportion,  9 
quoted  in, 

domestic  gold,  17 
foreign  gold,  18 

Rate  on  London  overdrafts, 

charge  for  overdue  payment  under 
sterling  import  credit,  146 

Ready  cable  exchange    (See   "Spot 
cable  exchange") 

Reimbursement  credit  (See  "Accep- 
tance credit") 

Retirement  rate, 
rebate    allowed    on    documentary 
payment  bills,  143,  145 

Russian  exchange,  par  of  exchange, 
163 

Russian  rouble,  gold  content,  163 


"Second    of    exchange,"    duplicate 

draft,  127 
Sight  exchange    (See   "Demand   ex- 
change") 
Silver  dollars, 

defect  in  legal  status,  120 
legal  tender  money,  120 
Spanish  exchange,  par  of  exchange, 

163 
Spanish  peseta,  gold  content,  163 
Specie  points  (See  also  "Spot  cable 
exchange,"    "Future    cable    ex- 
change,"    and     "Demand    ex- 
change") 
gold  export  and  import  points,  24 
variable,  30 
Speculation, 

future  exchange,  in,  55 
sterling  demand  exchange,  in,  128 
Spot  cable  exchange, 

arbitraging   between   purchase  of, 

and  gold  importation,  30 
arbitraging   between  sale  of,   and 

shipment  of  gold,  27 
arbitraging  with  demand  exchange, 
demand  price  above  parity,  75 
demand  rate  below  parity,  74 
arbitraging  with  future  cable  ex- 
change, 


INDEX 


i8i 


Spot  cable  exchange — Continued 

spot  parity  above  current  spot 
rate,  6i 

spot  parity  below  current  spot 
rate,  62 
common  rate  between  two  centers, 

how  determined,  48 
comparison  of  rates  in  two  centers, 

42 
dealt  in  in  foreign  center, 

relation  of  rate  to  demand  rate, 
81 

relation  of  rate  to  future  cable 
rate,  67 
defined,  14 
gold  export  point,  24 

rate  expressed  in  foreign  gold,  31 
gold  import  point,  24 

rate  expressed  in  foreign  gold,  31 
limitations  of,  70 
movement  in  rate  in  relation  to 

demand  rate,  76 
parity    of    rates    in    two    centers, 

different   systems    of    quotation 

used,  51 
parity     with     demand     exchange 

realized  to  greatest  extent,  75 
quoting  rate  in  foreign  gold,  18 
rate  in  one  center  above  parity 

rate  in  the  other,  42-43 
rate  of,  expressed  in  foreign  gold,  51 
rates  at  disparity, 

one  above  parity  of  other,  42 

one  below  parity  of  other,  45-47 
rates  at  parity  in  two  centers,  37 
relation  of  parity  rate, 

to  demand  rate,  73 

to  future  cable  rate,  59 
relation  of  specie  points  to   gold 

shipments,  66 
specie  points,  of,  when  expressed 

in  foreign  gold,  52 
tendency  of  rate  to  mutual  equal- 
ity in  two  markets,  41-47 
tendency  of  rate  to   parity   with 

demand  rate,  71-76 
tendency  of   rate  to   parity   with 

future  cable  exchange,  56-62 
tendency  to  parity  with  demand 

exchange, 

demand  price  above  parity,  74 

demand  rate  quoted  below  parity, 

73 
tendency    to    parity    with    future 
cable  exchange, 


spot  parity  rate  above  current 

spot  rate,  60 
spot  parity  rate  below  current 
spot  rate,  61 
Spot  cable  specie  points, 

tendency  of  rates  in  two  centers 

to    reach    concurrently    export 

point  in  one  and  import  point  in 

other,  49 

Spot  cable  transfer  (See  "Spot  cable 

exchange ' ') 
Spot    sterling    exchange, 

conversion  into   future   exchange, 

133 
"swapping"  for  future  exchange, 

134 
Standard  of  values,  gold,  2 
Sterling  bonds,  payable  in  London, 

158 
Sterling  cables, 

bankers'  and  commercial,  126 

both  deliveries  made  next  day,  126 

"cash"  transactions,  126 

operation  in,  illustrated,  125 

parity   with   sterling   demand   ex- 
change, 124 

rate  tends  to  equality  with  dollar 
cables  in  London,  124 

"swapping"     with     demand     ex- 
change, 129 
Sterling  demand  exchange, 

"cash"  transactions  in,  128 

commercial  bills,  128 

convenient  medium  of  speculation, 
128 

manner  of  trading,  126-128 

parity  with  sterling  cables,  124 

prime  bills,  128 

'swapping," 
between  prime  and  lower  grade 

bills,  129 
with  cables,  129 

time  of  payment  on,  127 

time  when  draft  is  delivered,  127 
Sterling  exchange, 

discount  on,  123 

in  Paris,  quoted  in  French  gold,  164 

manner  of  expressing  rates,  123 

par  of  exchange,  123 

pivotal  exchange,  165 

premium  on,  123 

rates,  regular  variations  in  market 
quotations,  125 

term  defined,  122 
Sterling  export  credit,  135-141 


I82 


INDEX 


Sterling     import     credit,     financing 
imports,  144 

Sterling  loan,  payable  in  London,  155 

Subsidiary  coins,  government's  obli- 
gations, 5 

Supply  of  exchange    (See   "Foreign 
exchange") 

"Swapping," 

foreign  currencies  in  New  York,  166 
future  sterling  exchange  for  spot, 

134 

long  bills,  152 

prime   and    lower    grade    demand 
bills,  129 

sterling    cables    and    demand    ex- 
change, 129 
Swedish  exchange,  par  of  exchange, 

163 
Swedish  krone,  gold  content,  163 
Swiss  exchange,  par  of  exchange,  163 

quoted  in  Swiss  gold,  163 
Swiss  franc,  gold  content,  163 


rate  above  parity,  106 
rate  below  parity,  105 

arbitraging, 

against  gold  shipments,  108 
different  methods  of,  109 

disparity  in  rates,  1 09 

gold  export  point,  107 

gold  import  point,  108 

illustrated,  loi 

parity  rate  for  franc  exchange,  164 

rates, 

interdependence  of,  loi 
parity  of,  103 
relationship  of,  107 
responsiveness  of,  106 

remitting,  six  methods  of,  108 

tendency  to  parity,  104-107 
rate  above  parity,  105 
rate  below  parity,  104 
Two-name  bill,  long  banker's  bill,  151 
Types  of  foreign  exchange  transac- 
tions, 

based  on  time  of  two  gold  deliver- 
ies,   10 

tendency  of  rates  to  mutual  equi- 
valence, II 


Three-cornered  excnange  (See* 'Trian- 
gular exchange") 

Treasury  notes  of  1890,  legal  tender 
money,  120 

Triangular  exchange, 
arbitrage, 


United  States  Government  Treasury, 

reservoir  of  gold,  121 
United    States    notes,    legal    tender 

money,  120 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 
BERKELEY 

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